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The Bush Tax Cuts: How did they affect corporate investment?

The Bush tax cuts directly lowered the after-tax user cost of capital. But this reduction must be balanced against the increase in that user cost due to the larger budget deficits and higher interest rates brought about by the tax cuts. Research into the effects of the tax cuts has shown that when the analysis includes even relatively modest effects of the larger deficits on interest rates, the net effect is to raise the user cost of capital under almost all the scenarios considered.

  • Traditionally, the effects of tax policy on firms’ demand for investment are summarized in estimates of the user cost of capital, which is the minimum return a firm needs to cover depreciation, taxes, and the opportunity costs of the funds used to finance the project. (The opportunity cost can be thought of as the cost of borrowing money to finance the investment, or the returns that are sacrificed when funds are invested in physical equipment rather than in financial instruments.) A lower user cost of capital typically translates into higher investment.
  • A number of studies have suggested that lower tax rates, like those enacted in the first term of the Bush administration, generally reduce the user cost of capital and thus boost corporate investment. However, these analyses have either explicitly or implicitly considered tax changes that are revenue-neutral-that is, cuts in tax rates that are paid for either by offsetting increases in other parts of the tax code or by lower government spending. The Bush tax cuts, in contrast, were not immediately offset by other spending cuts or tax increases. Consequently, it is not be appropriate to conclude from an analysis of the direct effects alone that the Bush tax cuts lowered the user cost of capital.
  • One study explicitly studied the effects of the provisions of the Bush tax cuts directed toward corporate investment, notably the bonus depreciation provisions, and found that their aggregate impact on investment was just 1 to 2 percent, "far too small to offset the double-digit declines of the early 2000s."
 
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