Investment Tax Incentives and Frequent Tax Reforms

Abstract

Despite the frequency of tax changes and their potential importance to investors, almost all of the analysis of tax-based investment incentives assumes investors never anticipate any tax changes.We depart from this approach by analyzing the historical pattern of U.S. corporate investment incentives over the period 1953-86, Incorporating the feature of investor awareness that the tax code may change.Our analysis incorporates a predictive equation for future tax variables into a model of optimal investment subject to adjustment costs and uncertainty.We find that expectations of future tax changes significantly affect the incentive to Invest only if adjustment costs are low.[n this case, the incentive to invest in 1986 was strong, as investors are estimated to have anticipated the coming reduction in investment incentives.

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