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

43 Pages Posted: 22 Sep 2000 Last revised: 28 Jul 2010

See all articles by Kevin A. Hassett

Kevin A. Hassett

American Enterprise Institute (AEI)

Gilbert E. Metcalf

Tufts University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: June 1994

Abstract

In models with irreversible investment, increasing uncertainty about prices has been shown to increase the required rate of return (hurdle rate) and delay investment (e.g., Pindyck, 1988). One serious form of uncertainty faced by firms, a form that policy makers could conceivably control, is tax uncertainty. In this paper, we show that it does not follow from past work that tax policy uncertainty increases the expected hurdle price ratio and delays investment. This is because tax uncertainty has an unusual form that distinguishes it from price uncertainty: tax rates tend to remain constant for many years, and then change in large jumps. When tax policy follows a jump process, firms' expectations of the likelihood of the jump occurring have important effects on investment. Indeed, as we show below, while price uncertainty increases the hurdle rate and slows down investment, tax uncertainty has the opposite effect.

Suggested Citation

Hassett, Kevin A. and Metcalf, Gilbert E., Investment with Uncertain Tax Policy: Does Random Tax Policy Discourage Investment? (June 1994). NBER Working Paper No. w4780. Available at SSRN: https://ssrn.com/abstract=227009

Kevin A. Hassett (Contact Author)

American Enterprise Institute (AEI) ( email )

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Gilbert E. Metcalf

Tufts University - Department of Economics ( email )

Medford, MA 02155
United States
617-627-3685 (Phone)
617-627-3917 (Fax)

National Bureau of Economic Research (NBER)

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