EXPERIMENTAL-EVIDENCE ON TAX INCENTIVES AND THE DEMAND FOR CAPITAL INVESTMENTS

Since the pioneering work of Hall and Jorgenson (1967), numerous studi es (e.g., Bischoff 1971; Chirinko and Eisner 1982; and Coen 1971) have examined the effect of attempts by the tax authority to influence inv estment decisions through accelerated depreciation or investment tax c redits (ITC). This body of research has been fraught with econometric estimation problems, and consequently has failed to provide a clear pi cture of the effect of tax policies on capital investment. In a review of the literature, Chirinko (1986, 151) concludes that ''[w]hile inve stment may respond significantly to variations in tax parameters, it a ppears to this author that the supporting empirical evidence has yet t o be generated.'' At the core of the difficulties in the econometric r esearch paradigm is the operationalization of the neoclassical investm ent function itself. Chirinko (1986) notes that numerous inherent diff iculties are introduced, including (1) estimations of the purchase cos t of a unit of capital, financial cost of capital net of inflation, ra te of depreciation of the capital good, rate of income taxation, rate of investment credit, discounted value of depreciation allowances, net cost of debt finance, and the like; and (2) the inability to control for firms' expectations regarding output, and hence the marginal produ ct of capital. These difficulties highlight the general limitations of econometrics in certain settings. This sentiment was echoed by Chirin ko and Eisner (1983, 139) when they concluded that, in the neoclassica l tax policy arena, ''one can get almost any answer one wants by makin g sure that the chosen model has specifications appropriate to one's p urpose.'' In response to the inconclusive econometric evidence regardi ng the effect of tax incentives on capital investment, we adopt an alt ernative approach in this study, using laboratory markets to overcome the limitations noted above, thereby providing a controlled empirical test of neoclassical predictions. Although the results of our experime nts provide no evidence regarding the real-world dollar responses of i nvestment to income tax accounting subsidies, some insight into the ab ility of theory to predict more general aspects of taxpayer investment behavior is provided. Specifically, the research question addressed i s whether capital investment increases when depreciation or investment credits allowed by the tax system result in more rapid deductions tha n true economic depreciation. Although this question follows directly from neoclassical predictions, we relax the assumption of price taking to permit the more realistic consideration of market price adjustment s. The results of our experiments do not support the neoclassical pred iction that depreciable asset investment will increase in response to accelerated tax depreciation or to investment tax credits. Demand was unresponsive to tax incentives because the prices of depreciable asset s were bid up. That is, tax benefits were captured to some extent by f actor suppliers. From a theoretical perspective, the study's results p rovide a ''piece of the puzzle'' in light of conflicting or nonexisten t econometric evidence. In section 1, a description of the experimenta l setting and administration is provided. Theoretical predictions of i nvestment price and quantity are then derived from our experimental op erationalization of a production economy in section II. Finally, resul ts and conclusions are presented in sections III and IV, respectively.