Capital allowances and investment: evidence from UK corporate tax returns

Event Date: 26 November 2014

Seminar: Giorgia Maffini, Oxford University Centre for Business Taxation (joint with Michael Devereux and Jing Xing)

How do corporate tax incentives such as capital allowances affect firms' investment? We provide new empirical evidence on the effects of capital allowances employing confidential UK corporate tax returns (2001/02-2009/10). We exploit the 2004 exogenous changes in the qualifying threshold for first year capital allowances to conduct a difference-in-difference analysis.

Our results suggest that gross investment rate increased between 2.1 and 2.6 percentage points when firms became qualified for the  first year allowances, relative to firms that were never qualified. Using the tax return data and exogenous variation in firms' characteristics, we show that the cash flow channel through which capital allowances affect investment is not a first order conditioning factor of  firms' investment in our sample of UK companies.

We exploit the same exogenous differences in companies' characteristics to identify the presence of frictions in the investment decision process:  firms do not react immediately to higher capital allowances but only after some time.

Published: 11 February 2015