Comments and Discussion

Kevin A. Hassett: This paper by Mihir Desai and Austan Goolsbee examines the impact of recent corporate tax changes on investment behavior and investigates the impact of a possible capital overhang on investment. Since my fellow discussant will focus on the overhang issue, I will concentrate my remarks on the tax and investment side of the paper.

To summarize my conclusions: The paper is a good, state-of-the-art econometric effort that confirms many of the findings of the recent investment literature. The regression results are competently arrived at and believable. However, the authors' policy discussion and their discussion of the impact of recent tax reforms offer conclusions that do not follow from their results. In relating their results to the impact of current policies, the authors have favored some extreme assumptions that are not supported by their empirical work, all aligned in a manner to make the tax cuts seem ineffective. A more balanced assessment of the recent impact of the tax reforms would certainly be more favorable.

A Look at the Literature.

The first of the recent corporate tax changes reduced the user cost of capital by allowing firms to expense a fraction of their capital purchases. This expensing has been "temporary" from the outset, although there has been significant uncertainty about whether the expensing provisions would be allowed to expire. There is little dispute that this tax change will lower the user cost of capital. In a recent paper in the National Tax Journal, my coauthors and I found that this reduction would vary by asset class, averaging about 2 to 3 percent, if the change were viewed as permanent and if the expensing fraction were the original, lower number.¹ If instead the provision were expected to expire, firms would have an incentive to shift investment forward. We found that this effect would reduce the current user cost by much more.

The second change was to lower the tax rate on dividends and capital gains. The effect of this change on the user cost depends on the marginal source of finance. In another recent paper, my coauthor and I found that approximately half of all firms behave as if they use new share issues as their marginal source of finance,² and approximately half behave as if they use retained earnings. Accordingly, relying on a third recent paper, in which my coauthors and I modeled the impact of dividend tax law changes,³ I find that the reduction attributable to the recent changes would be quite large under the "old view" of dividend taxation and much smaller under the "new view." However, these conclusions depend crucially on unobservables. The most important of these are the marginal tax rates on dividends and on capital gains, which in turn depend on the nature of financial equilibrium. If, for example, a "Miller equilibrium" describes the world, the relevant rates are those at which the marginal investor is just indifferent between debt and equity, not the average observed rate. Across a range of assumptions, however, the dividend change reduces the cost of capital by about 7 percent on average, assuming that firms themselves are split 50-50 between the old and the new views.

More recent evidence consistent with the idea that there exist both old and new view firms includes work by James Poterba,⁴ who has found that dividend payout responds significantly to tax changes, and by Raj Chetty and Emmanuel Saez,⁵ who found that dividend payouts increased sharply after the recent change in the law. In a work in progress, Alan Auerbach and I are exploring share price responses to the dividend change and finding results that confirm the conclusions in our earlier paper. There thus appears to be a great deal of heterogeneity in the data, with some firms behaving according to the old view and some according to the new view.

Whether these changes would result in a stimulus to investment depends on the elasticity of investment with respect to the user cost. Glenn Hubbard and I, in our chapter in the Handbook of Public Economics, concluded that the literature...