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

  • Kevin A. Hassett
  • Gilbert E. Metcalf


The authors consider the impact of tax policy uncertainty on firm level and aggregate investment, comparing investment behavior when uncertainty is due to a shock following geometric Brownian motion (GBM) versus when random discrete jumps in tax policy occur. Expectations of the likelihood of a tax policy switch have an important negative impact on the gain to delaying investment in the latter model and time to investment can fall with increasing tax policy uncertainty. Aggregate investment simulations indicate that capital formation is adversely affected by increases in uncertainty in the traditional GBM model but can be enhanced in the jump process model.

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Paper provided by Department of Economics, Tufts University in its series Discussion Papers Series, Department of Economics, Tufts University with number 9823.

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Date of creation: 1998
Date of revision:
Handle: RePEc:tuf:tuftec:9823
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  1. Andrew B. Abel, 1984. "A Stochastic Model of Investment, Marginal q and the Market Value of theFirm," NBER Working Papers 1484, National Bureau of Economic Research, Inc.
  2. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
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  4. Robert S. Pindyck, 1986. "Irreversible Investment, Capacity Choice, and the Value of the Firm," NBER Working Papers 1980, National Bureau of Economic Research, Inc.
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  6. 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.
  7. Dixit, Avinash, 1993. "Choosing among alternative discrete investment projects under uncertainty," Economics Letters, Elsevier, vol. 41(3), pages 265-268.
  8. Auerbach, Alan J & Hines, James R, Jr, 1988. "Investment Tax Incentives and Frequent Tax Reforms," American Economic Review, American Economic Association, vol. 78(2), pages 211-16, May.
  9. Koenker, Roger W & Bassett, Gilbert, Jr, 1978. "Regression Quantiles," Econometrica, Econometric Society, vol. 46(1), pages 33-50, January.
  10. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
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  14. Caballero, Ricardo J. & Pindyck, Robert S., 1992. "Uncertainty, investment, and industry evolution," Working papers 3460-92., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  15. Metcalf, Gilbert E. & Hassett, Kevin A., 1995. "Investment under alternative return assumptions Comparing random walks and mean reversion," Journal of Economic Dynamics and Control, Elsevier, vol. 19(8), pages 1471-1488, November.
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  17. Ricardo J. Caballero & Eduardo M. R. A. Engel & John C. Haltiwanger, 1995. "Plant-Level Adjustment and Aggregate Investment Dynamics," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 26(2), pages 1-54.
  18. B. Douglas Bernheim & John B. Shoven, 1991. "National Saving and Economic Performance," NBER Books, National Bureau of Economic Research, Inc, number bern91-2, December.
  19. Hartman, Richard, 1972. "The effects of price and cost uncertainty on investment," Journal of Economic Theory, Elsevier, vol. 5(2), pages 258-266, October.
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