Essays on Taxation and Investment

This thesis consists of three essays that examine the impact of tax policy on firms’ decisions to invest in productive capital. The first chapter uses newly-collected data on transaction prices of used construction machinery to examine the impact and incidence of recent tax incentives for investment. Theory predicts that incentives applying only to new investment should drive a wedge equal to the value of the incentives between the prices of new machines and equally productive used machines. The estimated effect of recent “bonus depreciation” incentives on the size of this wedge is close to zero. The total supply of machines, however, is highly price elastic. Together, these results suggest that the effectiveness of tax incentives that succeeded in stimulating investment demand would not be blunted by inelastic supply, but that the most recent set of tax incentives did little to stimulate investment demand. The second chapter documents the prevalence of losses among US corporations in recent years and examines their implications for the effectiveness of tax incentives for investment. Results suggest that asymmetries in the corporate tax code made recent bonus depreciation tax incentives about 5% less effective than they otherwise would have been. Recent declines in the ratio of cash flows to assets made bonus depreciation as much as 24% less effective than it otherwise would have been. Thus, recent losses can explain only part of the observed ineffectiveness of bonus depreciation. The final chapter estimates the response of dividend payouts to a 2003 dividend tax cut using a new control group of unaffected firms. Dividend payouts by real estate investment trusts rose sharply following the tax cut, even though REIT dividends did not benefit from the cut. It appears that the surge in aggregate dividend payouts subsequent to the tax cut was driven primarily by an increase in corporate earnings. Evidence from the tax cut thus provides little support for the claim that dividend taxation creates large distortions to firm investment decisions or large efficiency costs. Thesis Supervisor: James Poterba Title: Mitsui Professor of Economics Thesis Supervisor: Jerry Hausman Title: John and Jennie S. MacDonald Professor of Economics