Taxation, user cost of capital and investment behaviour of New Zealand firms

Abstract

This paper investigates the relationship between the user cost of capital (UCC) and the investment behaviour of New Zealand firms both in the short and long run. The key goal is to understand how policy changes that influence this cost of capital translate into changes in productive investment in New Zealand. Previous analysis on the UCC investment relationship in New Zealand focused on short term impacts on overall investment, and implied there was a limited investment response among capital heavy manufacturing firms. This was at odds with results from other countries (e.g. Belgium, France, Germany, UK). Our paper extends the New Zealand analysis in two ways: it re-estimates the prior results based on additional data and improved specification tests, and it also estimates an error-correction model that more consistently estimates the long-term impact of UCC changes on the capital stock. Our short-run findings are relatively consistent with prior New Zealand research. However, the long-run response of investment with respect to UCC changes (an elasticity of -1.4) is much larger than that implied in the prior research and previous estimates from macrodata. Furthermore, manufacturing firms also appeared to change their capital stock sizably from these estimates. The large response from our error correction estimates imply that the non-linearity of the dynamics of any investment response (e.g. due to lumpiness) needs to be accounted for when considering the long run consequences of any policy changes that affect the user cost of capital.