Research Discussion Paper – RDP 2018-07 The GFC Investment Tax Break

The Australian Government established a temporary tax break for investment as part of its stimulus response to the global financial crisis. The policy gave all businesses undertaking equipment investment extra tax deductions and gave larger deductions to small businesses. We exploit this differential treatment to identify the effect of the tax credit using business-level datasets from the Australian Bureau of Statistics. The key conclusions that emerge are:

1. The tax break had a strong effect on business-level investment. We find this result using both difference-in-differences and regression discontinuity methods.
2. The tax break increased the investment of companies, despite Australia's imputation system for corporate dividends implying that their costs of capital were unaffected. This suggests that a non-standard mechanism, such as a relaxation in financial constraints, underlies part of the response to tax incentives. To the extent that this is the case, it may suggest that such policies are more effective during downturns, when financial constraints are more binding. Relatedly, there is no evidence that businesses responded by bringing forward investment from future years (i.e. intertemporal substitution).
3. The tax break was important on a macroeconomic level. General equilibrium estimates suggest that both GDP growth and the cash rate would have been significantly lower in 2009 without the tax break.

While our work suggests that tax rates and breaks can affect real decisions for Australian corporates, despite the existence of the dividend imputation system, it provides only limited guidance on the potential effects of policies other than the one we study. Other policies will differ in terms of their timing, permanence and targeting, all of which could influence their effectiveness.