How responsive is business capital formation to its user cost? An exploration with micro data

The response of business capital formation to its user cost is critical to evaluating tax reform, deficit reduction, and monetary policy. Evidence for a substantial user cost elasticity, however, is sparse. Most evidence has been based on aggregate data, although several recent studies with firm-lev el data report substantial effects. With a particularly rich micro dataset containing over 26,000 observations, this paper explores what can be learne d about the user cost elasticity. While the results depend to some extent o n the specification and econometric technique, various diagnostics lead us to prefer a precisely estimated but small elasticity of approximately - 0.2 5. This paper is dedicated to the memory of Robert Eisner, who labored early a nd ably on uncovering the determinants of investment spending and highlight ing the importance of the question found in the title of this paper. (C) 19 99 Elsevier Science S.A. All rights reserved.