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Corporate Taxation and Investment: Explaining Investment Dynamics with Firm-Level Panel Data

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  • Nadja Dwenger

Abstract

Using a firm-level panel data set I assess whether dynamic models of in- vestment provide an empirically fruitful framework for analyzing tax effects on changes in capital stock. In particular I estimate a one-step error correction model (ECM) complementing the usual estimation of a distributed lag model. A correction term accounts for non-random sample attrition, which has not been considered in previous studies on investment even though most (if not all) panel data sets on firms are incomplete. Both, ECM and distributed lag model, suggest that user cost of capital and output have an economically and statistically significant influence on capital formation. In the ECM, however, estimates are larger in size and match theoretical pre- dictions more closely. My preferred estimate of -1.3 implies that a decrease in the user cost of capital by 10 percent will increase the firm's capital stock by 13 percent, on average. Taking my elasticity estimate to the Corporate Tax Reform 2008 I would expect that the reform only slightly increases cap- ital stock, since the rather strong reduction in corporate income tax rate was partly compensated for by stricter depreciation allowances. Investment dynamics appear to be crucial for the coefficients of cash flow variables in investment equations. While cash flow effects are present in the (first- differenced) distributed lag model, they vanish in the ECM. This leads me to conclude that well documented cash flow effects point at dynamic misspecification in previous studies.

Suggested Citation

  • Nadja Dwenger, 2009. "Corporate Taxation and Investment: Explaining Investment Dynamics with Firm-Level Panel Data," Discussion Papers of DIW Berlin 924, DIW Berlin, German Institute for Economic Research.
  • Handle: RePEc:diw:diwwpp:dp924
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    References listed on IDEAS

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    1. von Kalckreuth, Ulf, 2001. "Monetary transmission in Germany: New Perspectives on Financial Constraints and Investment Spending," Discussion Paper Series 1: Economic Studies 2001,19, Deutsche Bundesbank.
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    Cited by:

    1. Daniela Federici & Valentino Parisi & Caroline Elliott, 2015. "Do corporate taxes reduce investments? Evidence from Italian firm-level panel data," Cogent Economics & Finance, Taylor & Francis Journals, vol. 3(1), pages 1012435-101, December.

    More about this item

    Keywords

    Taxation; business investment; user cost of capital; dynamic specification;

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm

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