Do Tax Allowances Stimulate Investment?

Considerable empirical work on investment behavior makes use of a capital cost variable to capture the effects of various corporate tax allowances. The assumption behind most of this work is that all available tax allowances may be claimed by the firms. However, there are several reasons why this may not be true. One purpose of this paper is to explore the effect on capital cost of assuming that firms have unused tax allowances and that the investment funds system (IF system) is not used to finance marginal investments during periods of IF releases. Another purpose is to construct econometric investment functions in order to compare the performance of alternative definitions of capital cost. In fact, the hypothesis that tax allowances do not have the effect on capital cost implied by a mechanical interpretation of statutory tax rules cannot be rejected. In particular, IF releases may raise the return on intramarginal investment rather than create investment incentives.