The Role of Leasing in the Effectiveness of Corporate Tax Policy: Evidence from the 2002 Bonus Depreciation

Firms can use capital that they either purchase or lease, but these alternatives are treated differently for tax purposes. This paper derives the demand for leased capital as a function of tax parameters, and uses the model to estimate the responsiveness of leasing to the introduction of bonus depreciation in 2002, finding strong evidence that depreciation allowances influence leasing patterns. Firms that stood to benefit the least from depreciation allowances were the most likely to lease capital after the introduction of bonus depreciation. Specifically, I find that a lessee with a marginal tax rate of zero increases the fraction of leased investment by around 12% point in response to the 2002 bonus depreciation, compared to a fully taxed lessee. This evidence carries implications for the magnitude of deadweight losses due to financing distortions introduced by the corporate tax. JEL Codes: H25, H32, G31, G32.