Investment with Uncertain Tax Policy: Does Random Tax Policy Discourage Investment?

Kevin Hassett and Gilbert Metcalf

No 4780, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In models with irreversible investment, increasing uncertainty about prices has been shown to increase the required rate of return (hurdle rate) and delay investment (e.g., Pindyck, 1988). One serious form of uncertainty faced by firms, a form that policy makers could conceivably control, is tax uncertainty. In this paper, we show that it does not follow from past work that tax policy uncertainty increases the expected hurdle price ratio and delays investment. This is because tax uncertainty has an unusual form that distinguishes it from price uncertainty: tax rates tend to remain constant for many years, and then change in large jumps. When tax policy follows a jump process, firms' expectations of the likelihood of the jump occurring have important effects on investment. Indeed, as we show below, while price uncertainty increases the hurdle rate and slows down investment, tax uncertainty has the opposite effect.

JEL-codes: H2 H3 (search for similar items in EconPapers)
Date: 1994-06
Note: PE
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (19)

Published as Economic Journal, Vol. 109, no. 457 (July 1999): 372-393.

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Related works:
Journal Article: Investment with Uncertain Tax Policy: Does Random Tax Policy Discourage Investment? (1999)
Working Paper: Investment With Uncertain Tax Policy: Does Random Tax Policy Discourage Investment? (1998)
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