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General-equilibrium effects of investment tax incentives

  • Rochelle M. Edge
  • Jeremy B. Rudd
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    This paper develops a new-Keynesian model with nominal depreciation allowances to consider the effects of temporary tax-based investment incentives on capital spending and real activity. In particular, we investigate the effects of a temporary expensing allowance on investment in partial and general equilibrium and challenge the conventional view, advanced by Auerbach and Summers (1979) and Judd (1985), that partial-equilibrium analyses overstate the calculated impact of such policies. We also explore two additional questions. First, we investigate a claim noted by Auerbach and Summers and analyzed by Christiano (1984) that such incentives can be destabilizing. Second, we consider the relative impact of two types of tax-based investment incentives: a temporary partial-expensing allowance and a temporary reduction in capital taxes.

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    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2010-17.

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    Date of creation: 2010
    Date of revision:
    Handle: RePEc:fip:fedgfe:2010-17
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    1. Abel, Andrew B., 1982. "Dynamic effects of permanent and temporary tax policies in a q model of investment," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 353-373.
    2. repec:oup:qjecon:v:115:y:2000:i:1:p:147-180 is not listed on IDEAS
    3. repec:oup:qjecon:v:93:y:1979:i:3:p:433-46 is not listed on IDEAS
    4. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    5. Judd, Kenneth L, 1985. "Short-run Analysis of Fiscal Policy in a Simple Perfect Foresight Model," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 298-319, April.
    6. Rochelle M. Edge & Jeremy B. Rudd, 2005. "Temporary partial expensing in a general-equilibrium model," Finance and Economics Discussion Series 2005-19, Board of Governors of the Federal Reserve System (U.S.).
    7. Miles S. Kimball, 1995. "The Quantitative Analytics of the Basic Neomonetarist Model," NBER Working Papers 5046, National Bureau of Economic Research, Inc.
    8. David F. Bradford, 1979. "The Incidence and Allocation Effects of a Tax on Corporate Distributions," NBER Working Papers 0349, National Bureau of Economic Research, Inc.
    9. Alan J. Auerbach, 1986. "Tax Reform and Adjustment Costs: The Impact on Investment and Market Value," NBER Working Papers 2103, National Bureau of Economic Research, Inc.
    10. John M. Abowd & David Card, 1986. "On the Covariance Structure of Earnings and Hours Changes," NBER Working Papers 1832, National Bureau of Economic Research, Inc.
    11. K. Huang & Z. Liu, . "Staggered price-setting, staggered wage-setting, and business cycle persistence," Working Papers 2000-28, Utah State University, Department of Economics.
    12. Christopher L. House & Matthew D. Shapiro, 2008. "Temporary Investment Tax Incentives: Theory with Evidence from Bonus Depreciation," American Economic Review, American Economic Association, vol. 98(3), pages 737-68, June.
    13. Alan J. Auerbach & Lawrence H. Summers, 1979. "The Investment Tax Credit: An Evaluation," NBER Working Papers 0404, National Bureau of Economic Research, Inc.
    14. Christiano, Lawrence J., 1984. "A reexamination of the theory of automatic stabilizers," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 20(1), pages 147-206, January.
    15. Cohen, Darrel S. & Hansen, Dorthe-Pernille & Hassett, Kevin A., 2002. "The Effects of Temporary Partial Expensing on Investment Incentives in the United States," National Tax Journal, National Tax Association, vol. 55(3), pages 457-66, September.
    16. Straub, Roland & Tchakarov, Ivan, 2007. "Assessing the impact of a change in the composition of public spending: a DSGE approach," Working Paper Series 0795, European Central Bank.
    17. Jason G. Cummins & Kevin A. Hassett & R. Glenn Hubbard, 1994. "A Reconsideration of Investment Behavior Using Tax Reforms as Natural Experiments," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 25(2), pages 1-74.
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