Cost Reductions Drive Business Investments, New Study Suggests
Recent findings from a study by the National Economic Research Bureau indicate that lowering the costs associated with business investments could significantly boost capital expenditures, more than analysts in government have typically believed. Essentially, it shows that even a small decrease, just one percentage point in capital costs, could lead to an increase in business investment rates anywhere from 1.7 to 3.0 percentage points.
The study explores a relatively straightforward idea: companies tend to invest more when tax policies make it financially easier to do so. This analysis looked at the aftermath of the 2017 Tax Cuts and Jobs Act (TCJA), which lowered corporate tax rates and permitted businesses to immediately deduct many investment expenses.
Researchers Jonathan Hartley, Kevin Hassett, and Joshua Lau utilized asset-level data to examine changes in investment behaviors across various industries. They treated the TCJA as a natural experiment, assessing how a reduction in what economists refer to as the “user cost of capital” translates into actual business decisions. Hassett, who served as Donald Trump’s national economic advisor, along with Hartley—a policy fellow and PhD candidate in economics at Stanford—collaborated with Rauh, a finance professor and senior researcher at the Hoover Institute.
The term “user cost” essentially represents the post-tax return a company needs to generate to justify its investments. A decline in this cost makes it more feasible for companies to pursue profitable projects. Traditionally, policymakers believed there was a weak link between tax alterations and business investment; however, this new research suggests a much stronger connection.
Hartley noted, “We’re expanding the existing literature on the investment-user cost relationship using the 2017 tax cuts as a sort of natural experiment.”
These findings come at a time when Senate negotiations are underway to finalize a significant legislation, which includes extending 100% bonus depreciation until 2029. Some lawmakers advocate for making these cost provisions permanent.
Interestingly, the paper argues that the influence of capital costs extends beyond mere initial investments; it actually appears to strengthen over time. Their observations indicate that the investment responses peaked a few years after the TCJA was enacted, especially in 2021 and 2022. This trend suggests that temporary measures might underperform compared to lasting reforms.
The study utilized detailed data from the Bureau of Economic Analysis (BEA) across 93 different asset types, analyzing how investment responses varied based on effective tax rates and depreciation rules. Sectors that benefit from expenses—like equipment and machinery—showed significantly higher investment growth compared to those less responsive to tax changes.
Moreover, the researchers decomposed the effects of corporate tax reductions under the TCJA and their impact on costs. They found that the notable rise in investment, particularly in subsequent years, was largely driven by changes made to capital cost recovery rules, indicating that bonus depreciation might have played a larger role in encouraging business investment than merely reducing tax rates.
Hartley emphasized, “Both the changes in the corporate tax rate and the full cost recovery aspects are reflected in the user cost of capital. As the tax rate falls, the cost of capital also decreases, particularly with alterations in depreciation rules.”
The study builds upon earlier work by Hassett and other economists and employs updated methodologies related to natural experiments post-2017. The authors believe that permanent full costs could serve as an essential lever for Congress to consider in search of investment-led growth.
As the Senate prepares to finalize these negotiations in the coming weeks, this research may significantly influence policy discussions and the assumptions used to evaluate the bill’s potential economic growth and revenue impact.
