Tax Elasticity Estimates for Capital Stocks in Canada

Jean-Francois Wen, Fatih Yilmaz and Danea Trejo

No 2020/077, IMF Working Papers from International Monetary Fund

Abstract: The paper provides estimates of the long-run, tax-adjusted, user cost elasticity of capital (UCE) in a small open economy, exploiting three sources of variation in Canadian tax policy: across provinces, industries, and years. Estimates of the UCE with Canadian data are less prone to the endogeneity problems arising from the effects of tax policy changes on the interest rate or on the price of capital equipment. Reductions in the federal corporate income tax rate during the early 2000s for service industries but not for manufacturing, which already benefited from a preferential tax rate, contribute to the identification of the UCE. To capture the long-run relationship between the capital stock and the user cost of capital, an error correction model (ECM) is estimated. Supplementary results are obtained from a distributed lag model in first differences (DLM). With the ECM, our baseline UCE for machinery and equipment (M&E) is -1.312. The corresponding semi-elasticity of the stock of M&E with respect to the METR is about -0.2, suggesting, for example, that a 5 percentage point reduction in the METR, say from 15 to 10 percent, would in the long run generate an increase of 1.0 percent in the stock of M&E. The UCE for non-residential construction is statistically insignificantly different from zero.

Keywords: WP; cost of capital; open economy; user cost of capital; rate of return; UCE estimate; investment tax credit; depreciation rate; Metr data; elasticities decrease; provincial sales tax; differenced GDP terms; machinery and equipment; Marginal effective tax rate; Stocks; Corporate income tax; Real interest rates; Tax allowances; Global; Capital Taxation; User Cost of Capital Elasticity (search for similar items in EconPapers)
Pages: 28
Date: 2020-05-29
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Related works:
Working Paper: Tax Elasticity Estimates for Capital STocks in Canada (2018)
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