Tax Policy Endogeneity: Evidence from R&D Tax Credits

58 Pages Posted: 15 Feb 2015

See all articles by Andrew C. Chang

Andrew C. Chang

Board of Governors of the Federal Reserve System

Date Written: November 21, 2014

Abstract

Because policymakers may consider the state of the economy when setting taxes, endogeneity bias can arise in regression models that estimate relationships between economic variables and taxes. This paper quantifies the policy endogeneity bias and estimates the impact of R&D tax incentives on R&D expenditures at the U.S. state level. Identifying tax variation comes from changes in federal corporate tax laws that heterogeneously impact state-level R&D tax incentives due to the simultaneity of state and federal corporate taxes. With this exogenous variation, my preferred estimates indicate a 1 percent increase in R&D tax incentives leads to a 2.8-3.8 percent increase in R&D. Alternatively, estimates that ignore endogenously determined policies indicate that a 1 percent increase in R&D tax incentives leads to a 0.4-0.7 percent increase in R&D. These results are consistent with tax policies that are implemented before an economic downturn.

Keywords: Corporate tax, fiscal policy, R&D price elasticity, tax credits, policy endogeneity

JEL Classification: H20, H25, H32, H71, K34, O38

Suggested Citation

Chang, Andrew C., Tax Policy Endogeneity: Evidence from R&D Tax Credits (November 21, 2014). FEDS Working Paper No. 2014-101, Available at SSRN: https://ssrn.com/abstract=2534549 or http://dx.doi.org/10.2139/ssrn.2534549

Andrew C. Chang (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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