Incentive effects of the investment tax credit: Evidence from analysts' forecasts

Abstract

Both federal and state governments have used the investment tax credit (ITC) as an investment incentive, but prior research provides conflicting results on the credit's success in encouraging capital investment. The inconsistent evidence may be attributable to the primary use of macroeconomic investment models and their inherent limitations. This study uses financial analysts' firm-specific forecasts of short-term and long-term capital expenditures as measures (or proxies) of firms' planned investment behavior. The ITC's incentive effects are estimated using revisions in forecasted capital expenditure amounts published before and after relevant tax legislation dates. In general, results suggest that ITC-related provisions have affected firms' short-term and long-term capital expenditure plans but that any incentive effects are concentrated primarily among low-debt firms and firms with positive taxable income. This study's results suggest that policymakers must consider the tax and nontax characteristics of the individual firms that comprise the population of firms targeted by tax policy changes. The effectiveness of tax incentives relies on these firm-specific characteristics, and failure to consider these firm-specific attributes will likely lead to errors in the estimated impact of tax policy changes. Overall, this study demonstrates the importance of examining tax policy in a microeconomic framework.