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Investment with Uncertain Tax Policy: Does Random Tax Policy Discourage Investment?

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  • Kevin Hassett
  • Gilbert E. Metcalf

Abstract

In models with irreversible investment, increasing uncertainty about prices has been shown to increase the required rate of return (hurdle rate) and delay investment (e.g., Pindyck, 1988). One serious form of uncertainty faced by firms, a form that policy makers could conceivably control, is tax uncertainty. In this paper, we show that it does not follow from past work that tax policy uncertainty increases the expected hurdle price ratio and delays investment. This is because tax uncertainty has an unusual form that distinguishes it from price uncertainty: tax rates tend to remain constant for many years, and then change in large jumps. When tax policy follows a jump process, firms' expectations of the likelihood of the jump occurring have important effects on investment. Indeed, as we show below, while price uncertainty increases the hurdle rate and slows down investment, tax uncertainty has the opposite effect.

Suggested Citation

  • Kevin Hassett & Gilbert E. Metcalf, 1994. "Investment with Uncertain Tax Policy: Does Random Tax Policy Discourage Investment?," NBER Working Papers 4780, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:4780
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    References listed on IDEAS

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    JEL classification:

    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents

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