NCPA - National Center for Policy Analysis


May 4, 2007

Tax subsidies for businesses are so strong that, for a sufficiently temporary tax change, firms will bid up the purchase price of investment goods by exactly the amount of the subsidy, says the National Bureau of Economic Research (NBER).

The researchers measured the effect of two tax laws, one that created (in 2002), and one that increased (in 2003) accelerated depreciation -- called bonus depreciation -- that allowed firms to immediately deduct an increased fraction of their investment spending.  The results:

  • The tax changes appear to have had a powerful effect on the composition of investment, which reacts strongly to changes in bonus depreciation.
  • Their analysis also 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.
  • Capital that benefited substantially from the policy -- namely equipment with long tax lives -- saw sharp increases in investment.

Although the policy expired in 2005, it is not clear whether investment spending returned to normal, as one would predict.  This is probably because of the extension of bonus depreciation for certain properties and the increased Section 179 exemption, a tax incentive that shares many of the features of bonus depreciation but, unlike bonus depreciation, was extended beyond the end of 2004.

Source: Les Picker, "Tax Incentives Raised Business Investment," NBER Digest, April 2007; based upon: Christopher House and Matthew Shapiro, " Temporary Investment Tax Incentives: Theory with Evidence from Bonus Depreciation," National Bureau of Economic Research, Working Paper No. 12514, September 2006.

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