On the Effects of Investment Tax Credits on Economic Efficiency and Growth: Should an Investment Tax Credit be Reintroduced?

Abstract

In this paper, the reintroduction of Investment Tax Credits (ITC's) is analyzed in the context of a dynamic general equilibrium model of the U.S. economy. This model postulated forward looking investment decisions, and allows for endogenous government deficits and financial crowding-out. Also, it captures optimal labor-consumption and saving decisions. Simulation results suggest that the reintroduction of the ITC's would generate efficiency losses about 15 billion of 1973 dollars under the best scenarios. The efficiency losses confirm the conventional wisdom about the distortionary effects of the ITC's. In turn, the global effects on investment demand and economic growth are negative. This challenges the conventional wisdom by emphasizing the importance of the marginal financial crowding-out effects associated to increased government deficits. Globally speaking, the reintroduction of ITC's does not appear to be a good idea.