Tax Policy Expectations and Investment: Evidence from the 2016 U.S. Election and the Tax Cuts and Jobs Act

Abstract

We examine how tax policy expectations evolve around and shape firms’ investment response to a change in tax policy. Our study is motivated by Hennessy and Strebulaev (2020), who show analytically that bias arising from unmeasured policy expectations can confound inferences regarding the causal impact of a policy change on investment. Using a text-based approach to measuring firms’ tax policy expectations, we document that two recent tax-changing events—namely, the 2016 U.S. election and the Tax Cuts and Jobs Act (TCJA)—affected these expectations in ways that vary considerably across firms and sometimes contrary to often-used conventional assumptions (e.g., uncertainty over tax policy, on average, is found to increase after the election). As for the TCJA, we observe that these event-induced tax policy expectations materially shape investment both before and in response to its passage. Our findings support the idea that firm-level tax policy expectations can affect investment behavior around a change in tax policy, and suggest a methodology that researchers can use to incorporate these policy expectations into their analysis of tax policy.

Keywords: policy expectations, tax policy, tax reform, investment

JEL Classification: D72, G31, G38, H25