Estimating the impact of investment tax credits on aircraft demand

This paper uses exogenous price changes from the shifting tax policies of the 1980’s to identify the parameters of a nested-logit discrete choice model of the aircraft market. The federal Investment Tax Credit (ITC) was a tax credit of 6-10% of a firm's new capital investment that was removed by the Tax Reform Act of 1986 (TRA86). Such tax credits continue to be proposed as tools to spur investment, and they are still utlized in many states and select industries. This research adds to the small body of empirical work on taxes in imperfectly competitive markets. I model the oligopoly market structure of aircraft manufacturers by assuming Bertrand competition. The demand-side parameters are estimated using 2SLS with cost-shifting instruments. The demand-side choices are purchasing new or used aircraft, or refraining from purchasing an aircraft. I then estimate linear mark-up equations using the demand-side parameter estimates and other cost variables. I use the full set of parameter estimates to simulate aircraft transactions before and after the TRA86. This structural approach allows me to isolate the effects of the ITC through counterfactual policy simulations. I find that the ITC encourages firms to upgrade to more expensive capital by purchasing a more expensive aircraft than they would have without the ITC; however, the ITC has very limited impact enticing firms to purchase new aircraft instead of used aircraft. The overall effect on new purchases is small. Thus, most of the incidence of the tax credit was gained by the suppliers of aircraft; moreover the ITC exacerbated the market power of suppliers, leading to further distortions.