Finance and Economics Discussion Series

General-Equilibrium Effects of Investment Tax Incentives

Rochelle M. Edge and Jeremy B. Rudd
2010-17

Abstract: This paper develops a new-Keynesian model with nominal depreciation allowances to consider the effects of temporary tax-based investment incentives on capital spending and real activity. In particular, we investigate the effects of a temporary expensing allowance on investment in partial and general equilibrium and challenge the conventional view, advanced by Auerbach and Summers (1979) and Judd (1985), that partial-equilibrium analyses overstate the calculated impact of such policies. We also explore two additional questions. First, we investigate a claim noted by Auerbach and Summers and analyzed by Christiano (1984) that such incentives can be destabilizing. Second, we consider the relative impact of two types of tax-based investment incentives: a temporary partial-expensing allowance and a temporary reduction in capital taxes.

Keywords: New-Keynesian model, business equipment investment, nominal depreciation allowances, partial-expensing allowances, bonus-depreciation allowances