Tax Elasticity Estimates for Capital Stocks in Canada

By Jean-François Wen, Fatih Yilmaz, Danea Trejo

May 29, 2020

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Jean-François Wen, Fatih Yilmaz, and Danea Trejo. Tax Elasticity Estimates for Capital Stocks in Canada, (USA: International Monetary Fund, 2020) accessed November 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

The paper provides estimates of the long-run, tax-adjusted, user cost elasticity of capital (UCE) in a small open economy, exploiting three sources of variation in Canadian tax policy: across provinces, industries, and years. Estimates of the UCE with Canadian data are less prone to the endogeneity problems arising from the effects of tax policy changes on the interest rate or on the price of capital equipment. Reductions in the federal corporate income tax rate during the early 2000s for service industries but not for manufacturing, which already benefited from a preferential tax rate, contribute to the identification of the UCE. To capture the long-run relationship between the capital stock and the user cost of capital, an error correction model (ECM) is estimated. Supplementary results are obtained from a distributed lag model in first differences (DLM). With the ECM, our baseline UCE for machinery and equipment (M&E) is -1.312. The corresponding semi-elasticity of the stock of M&E with respect to the METR is about -0.2, suggesting, for example, that a 5 percentage point reduction in the METR, say from 15 to 10 percent, would in the long run generate an increase of 1.0 percent in the stock of M&E. The UCE for non-residential construction is statistically insignificantly different from zero.

Subject: Corporate income tax, Financial institutions, Financial services, Marginal effective tax rate, Real interest rates, Stocks, Tax allowances, Tax policy, Taxes

Keywords: Capital Taxation, Corporate income tax, Cost of capital, Depreciation rate, Differenced GDP terms, Elasticities decrease, Global, Investment tax credit, Machinery and equipment, Marginal effective tax rate, Metr data, Open economy, Provincial sales tax, Rate of return, Real interest rates, Stocks, Tax allowances, UCE estimate, User cost of capital, User Cost of Capital Elasticity, WP

Publication Details

Pages:

28
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2020/077
Stock No:

WPIEA2020077
ISBN:

9781513545981
ISSN:

1018-5941

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