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Saturday, April 28, 2007

House & Shapiro on Temporary Investment Tax Incentives: Theory With Evidence from Bonus Depreciation

SsrnChristopher L. House & Matthew D. Shapiro (both of the University of Michigan, Department of Economics) have posted Temporary Investment Tax Incentives: Theory With Evidence from Bonus Depreciation on SSRN.  Here is the abstract:

Investment decisions are inherently forward-looking. The payoff of acquiring capital goods, particularly long-lived capital goods, is governed almost exclusively by events in the far future. Because the timing of the investment itself does not affect future payoffs, there are strong incentives to delay or accelerate investment to take advantage of predictable intertemporal variations in cost. For sufficiently long-lived capital goods, these incentives are so strong that the intertemporal elasticity of investment demand is nearly infinite. As a consequence, for a temporary tax change, the shadow price of long-lived capital goods must reflect the full tax subsidy regardless of the elasticity of investment supply. While price data provide no information on the elasticity of supply, they can reveal the extent to which adjustment costs are internal or external to the firm. In contrast, the elasticity of investment supply can be inferred from quantity data alone. The bonus depreciation allowance passed in 2002 and increased in 2003 presents an opportunity to test the sharp predictions of neoclassical investment theory. In the law, certain types of long-lived capital goods qualify for substantial tax subsides while others do not. The data show that investment in qualified properties was substantially higher than for unqualified property. The estimated elasticity of investment supply is high--between 10 and 20. Market prices do not react to the subsidy as the theory dictates. This suggests either that internal (unmeasured) adjustment costs play a significant role or that measurement problems in the price data effectively conceal the price changes. While the policy noticeably increased investment in types of capital that benefited substantially from bonus depreciation, the aggregate effects of the policy were modest. The analysis suggests that the policy may have increased output by roughly 0.1 percent to 0.2 percent and increased employment by roughly 100,000 to 200,000 jobs.

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Comments

I remember the ten percent investment tax credits that used to get businesses to buy equipment every year, even if it was after Christmas. This especially helped small businesses. Want to see more investments? Put that back in.

Posted by: Woody | Apr 28, 2007 4:36:36 PM

Which is worth more: a tax credit for ten-percent of basis OR a deduction for 50% of basis that can be used in conjunction with the 179 expensing election (assuming taxpayers can use it)?

Keep in mind that ITC property is equivalent to short-life MACRS property (5-15 year), but does not include apartment property. So bonus depreciation will apply to more assets.

Also, bonus depreciation, along with Rev. Proc. 2002-19, added to the explosion in cost segregation firms, which seriously skews the quality of tax data. You can't tell if they're buying equipment or putting up a new office wall.

Posted by: Coach | Apr 29, 2007 9:58:10 AM