Tax Policy and Irreversible Investment

Centre for Dynamic Macroeconomic Analysis Working Paper No. 0404

67 Pages Posted: 9 May 2005

See all articles by Sumru Altug

Sumru Altug

American University of Beirut - Faculty of Arts & Sciences; Koc University - Department of Economics

Fanny Demers

Carleton University - Department of Economics

Michel Demers

Carleton University - Department of Economics

Date Written: November 2004

Abstract

We examine the impact of tax policy uncertainty on the irreversible investment decisions of a monopolistically competitive firm. We consider the impact of tax policy in terms of the investment tax credit (ITC) as well as the stochastic tax wedge which determines the after-tax costs of investing. We show that (i) temporary tax incentives have a greater stimulative impact on investment; (ii) greater policy volatility results in greater variability of investment; (iii) a stochastically larger future tax policy lowers current investment; and (iv) greater variability of tax policy around a constant mean leads to lower investment. We examine changes in the average levels of investment and its variability over short- and long-run horizons. We consider a general 3-state process, a log-normal process, and a Poisson process. We carry out an extensive sensitivity analysis that allows us to examine the impact of changes in real interest rates, and changes in the elasticity of demand facing firms.

Keywords: Irreversible investment, tax policy, changes in persistence, increases in risk

JEL Classification: E22, E62

Suggested Citation

Altug, Sumru and Demers, Fanny and Demers, Michel, Tax Policy and Irreversible Investment (November 2004). Centre for Dynamic Macroeconomic Analysis Working Paper No. 0404, Available at SSRN: https://ssrn.com/abstract=717882 or http://dx.doi.org/10.2139/ssrn.717882

Sumru Altug (Contact Author)

American University of Beirut - Faculty of Arts & Sciences ( email )

P.O.Box 11-0236 / (Department)
Beirut
Lebanon

Koc University - Department of Economics ( email )

Rumeli Feneri Yolu
Sariyer 34450, Istanbul
Turkey
(90 212) 338 1673 (Phone)
(90 212) 338 1651 (Fax)

Fanny Demers

Carleton University - Department of Economics ( email )

1125 Colonel By Drive
Faculty of Public Affairs & Management
Ottawa, Ontario
Canada K1S 5B6
613-520-2600 ext 3775 (Phone)

Michel Demers

Carleton University - Department of Economics ( email )

1125 Colonel By Drive
Faculty of Public Affairs & Management
Ottawa, Ontario
Canada K1S 5B6
613-520-2600 ext 3772 (Phone)

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