ERTA as an investment stimulus : a micro based analysis of firm investment behavior

The purpose of this dissertation is to estimate the effect of the Economic Recovery Tax Act of 1981 (ERTA) on capital investment. ERTA was aimed at stimulating investment by greatly accelerating depreciation deductions and liberalizing investment tax credits. The impact of these changes was to reduce significantly the effective tax rate firms have to pay on income from new capital. The investment stimulus due to ERTA is determined by using firm-specific data. Such an approach controls for factors that cannot be controlled at an aggregate level. A model of firm behavior is developed, where investment by the firm depends on the various prices it faces and on the tax policy environment. The data set used in this research consists of nominal and replacement cost data of 121 firms for the years 1978-1983. Recent changes in accounting reporting requirements have made possible calculation of inflation-adjusted costs and income at the firm level, allowing for the calculation empirically of the real incentives faced by corporations. The study finds that firms' investment decisions are based upon the availability of cash flow and interest rates. None of the tax variables are found to have a significant impact on investment. These findings are true across industries and across time.