How responsive is business capital formation to its user cost? An exploration with micro data

The response of business capital formation to its user cost is critical to evaluating tax reform, deficit reduction, and monetary policy. Evidence for a substantial user cost elasticity, however, is sparse. Most evidence has been based on aggregate data, although several recent studies with firm-level data report substantial effects. With a particularly rich micro dataset containing over 26,000 observations, this paper explores what can be learned about the user cost elasticity. While the results depend to some extent on the specification and econometric technique, various diagnostics lead us to prefer a precisely estimated but small elasticity of approximately - 0.25. This paper is dedicated to the memory of Robert Eisner, who labored early and ably on uncovering the determinants of investment spending and highlighting the importance of the question found in the title of this paper. (C) 1999 Elsevier Science S.A. All rights reserved.