Do Financial Frictions Amplify Fiscal Policy? Evidence from Business Investment Stimulus

From Erik Zwick and James Mahon:

We estimate the causal effect of temporary tax incentives on equipment investment using a difference-in-differences design and policy shifts in accelerated depreciation. Analyzing data for over 120,000 US firms from 1993 to 2010, we present three findings. First, bonus depreciation raised investment by 18.5 percent on average between 2001 and 2004 and 31.2 percent between 2008 and 2010. Second, financially constrained firms respond more than unconstrained firms. And third, firms respond strongly when the policy generates immediate cash flows, but do not respond at all when the policy only benefits them in the future. The results provide an estimate of the discount rate firms apply to future cash flows: constrained firms act as if $1 next year is worth 38 cents today. The estimated discount rate is too high to match the predictions of a frictionless model, nor can it be explained entirely by costly external finance, unless firms also neglect financial constraints binding in the future.