Investment, Accounting, and the Salience of the Corporate Income Tax

This paper develops the argument that accounting rules make the corporate income tax less salient and less distortionary by obscuring the timing of tax payments. I develop and estimate a model of investment where firms maximize a discounted weighted average of after-tax cash flows and accounting profits. The cost of capital, the tax wedge on the return on capital, and the impact of tax incentives for investment depend on the weight placed on accounting profits. I estimate this weight by comparing the effectiveness of tax incentives that do and do not affect accounting profits. Investment tax credits, which do affect accounting profits, have more impact on investment than accelerated depreciation, which does not. I argue that the difference in estimated impact is not driven by discounting, cash flow effects, or measurement error. The difference is larger among firms with higher measures of earnings management. Results thus suggest that the tax burden on corporate capital is lower than we would otherwise estimate, and accelerated depreciation provisions are less effective than they otherwise would be. ∗Email: [email protected]. Any views expressed here are those of the author only and need not represent the views of the Federal Reserve Board or the Federal Reserve System. I thank James Poterba, Nirupama Rao, Joel Slemrod, Johannes Spinnewijn, Ross Watts, and lunch participants at MIT for helpful comments and conversations.