The Impact of Depreciation Savings on Investment: Evidence from the Corporate Alternative Minimum Tax

Over the past decade, the United States has offered investment incentives in the form of larger depreciation savings, namely, bonus depreciation. The neoclassical investment model implies that investment responds to changes in depreciation savings, but there have been few direct attempts to investigate this implication. This paper examines investment patterns surrounding the 1999 shortening of the Alternative Minimum Tax (AMT) depreciation recovery periods, finding strong evidence that firms subject to the AMT increase investment in response to the AMT reform. The empirical results show that firms subject to the AMT increase their investment, measured as the ratio of capital expenditures to capital stock, by around 0.04 to 0.07, compared to firms subject to the regular tax. Given their average annual investment rate of approximately 0.25 during this period, the results imply a relative increase in investment of 17%-27%. By contrast, I find the 2002 introduction of bonus depreciation, available both for firms subject to the regular tax and for firms subject to the AMT, affects both groups of firms similarly. The estimation uses an empirical specification developed from the Summers (1981) tax-adjusted q model, and the results imply that the responsiveness of investment to the tax term is somewhat larger than previously estimated. ∗Email: [email protected]. I am grateful to Jim Hines, Uday Rajan, Matthew Shapiro, and Joel Slemrod for their guidance, support, and advice. I also thank David Agrawal, Roy Chen, Jane Gravelle, Jesse Gregory, Noam Gruber, Brad Hershbein, Jeff Hoopes, Bert Lue, Andrew Lyon, Nathan Seegert, Caroline Weber, David Wildasin (discussant) and participants at the 2011 National Tax Association Annual Conference and the University of Michigan Public Finance seminar for helpful comments at various stages of the research project. All errors are my own.