Investment, Overhang, and Tax Policy
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Investment, Overhang, and Tax Policy
Investment, Overhang, and Tax PolicyMihir A. Desai Harvard University and NBERAustan D. GoolsbeeUniversity of Chicago. American Bar Foundation and NBE Investment, Overhang, and Tax PolicyER38292We (hank Mark Veblen and James Zeltler for (heir invaluable research assistance and Alan Auerbach. Bill Brainard. Kevin Hassen. John Leahy, George Perry. Joel Slemrod. and participants ar (he BPEA conference for (heir comments. Dale Jorgenson was kind enough to provide cost of capital estimat Investment, Overhang, and Tax Policyes. Desai thanks the Division of Research at Harvard Business School for financial support.0Investment, Overhang and Tax Policy'ABSTRACTThe unusual beInvestment, Overhang, and Tax Policy
havior of investment in the 1990s and early 2000s—abnormally high investment in the 1990s and abnormally low investment in the 2000s, despite several Investment, Overhang, and Tax PolicyMihir A. Desai Harvard University and NBERAustan D. GoolsbeeUniversity of Chicago. American Bar Foundation and NBE Investment, Overhang, and Tax Policyc investment collapse of the early 2000’s? and Why has fiscal policy been unable to revive investment? We use firm level evidence to show that capital overhang - the notion that the late 1990s stock market bubble led to excess investment and prevented a rebound - is not a meaningful factor in explai Investment, Overhang, and Tax Policyning the fall of investment. Controlling for fundamentals, there is little evidence of capital overhang. We then modify the tax-adjusted q model to alInvestment, Overhang, and Tax Policy
low for clearer identification of tax effects in the presence of mismeasured q. This modification yields estimates that are larger and more precisely Investment, Overhang, and Tax PolicyMihir A. Desai Harvard University and NBERAustan D. GoolsbeeUniversity of Chicago. American Bar Foundation and NBE Investment, Overhang, and Tax Policyeffects of the tax cuts. First, in keeping with the “new" view of dividend taxation, the evidence suggests that dividend taxes do not influence marginal investment incentives. This evidence indicates that the dividend lax cut, with forecast revenue cost of more than S400 billion from 2003-2008, woul Investment, Overhang, and Tax Policyd have had little if any impact on investment. Second, the partial expensing of equipment provisions (revenue cost of approximately S130 billion fromInvestment, Overhang, and Tax Policy
2002-2004) did have an effect on investment but were too small to counteract the large aggregate investment declines stemming from market movements. TInvestment, Overhang, and Tax PolicyMihir A. Desai Harvard University and NBERAustan D. GoolsbeeUniversity of Chicago. American Bar Foundation and NBE Investment, Overhang, and Tax Policyorgan 363Soldiers FieldBoston, MA 02163 mdesai@hbs.eduAllStan D. GoolsbeeUniversity of Chicago Business Schoolgoolsbee@gsb.uchicago.edu11. introductionThe pattern of investment over the past decade has been unusual. The boom of the 1990s generated unusually high investment rates, particularly in equ Investment, Overhang, and Tax Policyipment, and the bust OÍ the 2000s witnessed an unusually large decline in investment. Drops in equipment investment normally account for about 10-20 pInvestment, Overhang, and Tax Policy
ercent of the decline in GDP during a recession but in 2001 accounted lor 120 percent of this del line.* 1In the public mind, the boom and bust in invInvestment, Overhang, and Tax PolicyMihir A. Desai Harvard University and NBERAustan D. GoolsbeeUniversity of Chicago. American Bar Foundation and NBE Investment, Overhang, and Tax Policye 1990s. fueled by an asset piicc bubble, left corporations with excess capital stocks and. therefore, no demand for investment dining the 2000s. rhe popular view also holds that these conditions will continue until normal economic growth eliminates the overhang and, consequently, there is little po Investment, Overhang, and Tax Policylicy makers can do about it by subsidizing investment with tax policy, for example. Variants on this view-have been extensively espoused by private seInvestment, Overhang, and Tax Policy
ctor analysts and economists (e.g., Bemer, 2001; Leach, 2002; Roach. 2002) and certainly has been on the minds of leading Federal Reserve officials (eInvestment, Overhang, and Tax PolicyMihir A. Desai Harvard University and NBERAustan D. GoolsbeeUniversity of Chicago. American Bar Foundation and NBE Investment, Overhang, and Tax Policy).Regardless of whether overhang is the true explanation of the investment bust, it is clear that the drop in investment has motivated policy makers to try to stimulate investment through large fiscal policy changes.* President Bush twice increased depreciation allowances (2002 and 2003) for equipme Investment, Overhang, and Tax Policynt investment and. in 2003, significantly cut the tax rate on dividend income and modestly cut the tax rate on capital gains income. These measures weInvestment, Overhang, and Tax Policy
re mainly intended to reduce the cost of capital and stimulate investment, rhe typical analysis of the investment collapse and policy response is summInvestment, Overhang, and Tax PolicyMihir A. Desai Harvard University and NBERAustan D. GoolsbeeUniversity of Chicago. American Bar Foundation and NBE Investment, Overhang, and Tax Policyen years to liquidate, in nine of the 10 quarters beginning1 McCarthy (2003) documents the equipment declines as a share of GDP declines for all of the cycles since 1953 and shows the 2001 recession to be an extreme outlier.1 Unlike investment behavior, this phenomenon of rhe 2000s is completely con Investment, Overhang, and Tax Policysistent with earlier rime periods. Cummins er al. (1994) have documented that a primary determinant of investment tax subsidies is a drop in investmenInvestment, Overhang, and Tax Policy
t.2the fourth quarter of2000. real business investment has actually declined. Fortunately, recent tax legislation signed into law in 2003 should promoInvestment, Overhang, and Tax PolicyMihir A. Desai Harvard University and NBERAustan D. GoolsbeeUniversity of Chicago. American Bar Foundation and NBE Investment, Overhang, and Tax Policyum-size firms." (Saxton, 2003).Yet, after several years of tax cuts, investment has still not risen impressively compared to previous recoveries. This contrast has reignited claims that tax policy is ineffective at stimulating investment, though some make the more specific charge that tax policy may Investment, Overhang, and Tax Policy only be impotent when it follows a period following excessive investment.In this paper, we attempt to examine the evidence on the two related issuesInvestment, Overhang, and Tax Policy
of overhang and taxes in some detail using micro data, usually at the firm level. Specifically we address two questions: 1) did "over"-investment of tInvestment, Overhang, and Tax PolicyMihir A. Desai Harvard University and NBERAustan D. GoolsbeeUniversity of Chicago. American Bar Foundation and NBE Investment, Overhang, and Tax Policyfically the equipment expensing and the dividend tax cuts of 2002 and 2003, have seemed to have so little ability to restore investment to normal levels?We begin by looking at correlations of investment during the boom and the declines in investment during the bust across different assets and indust Investment, Overhang, and Tax Policyries. There are, of course, many potential definitions of overhang or excess investment and we want to make clear at the outset that we will not be trInvestment, Overhang, and Tax Policy
ying to show there was no over-optimism in product or capital markets. Clearly equity prices rose and then fell as did investment rates. Instead we arInvestment, Overhang, and Tax PolicyMihir A. Desai Harvard University and NBERAustan D. GoolsbeeUniversity of Chicago. American Bar Foundation and NBE Investment, Overhang, and Tax Policybecause there is too much capital sitting around from the 1990s. That is our notion of overhang.We will start with some suggestive evidence on investment rates across industries, asset types, and firms. Contrary to the popular view, in all three cases, there is little correlation between the investm Investment, Overhang, and Tax Policyent boom of the 1990s and the investment bust of the 2000s. We will then present some specific evidence using firm level data that investment behaviorInvestment, Overhang, and Tax Policy
has remained just as responsive to fundamentals'prices (as measured by Tobin’s q) regardless of how much investment growth or equity price growth theInvestment, Overhang, and Tax PolicyMihir A. Desai Harvard University and NBERAustan D. GoolsbeeUniversity of Chicago. American Bar Foundation and NBE Investment, Overhang, and Tax Policydeteriorated in the 2000s, despite the common perception that the current period is unusual.Investment, Overhang, and Tax PolicyMihir A. Desai Harvard University and NBERAustan D. GoolsbeeUniversity of Chicago. American Bar Foundation and NBEGọi ngay
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