Investment and Taxation in Germany* - Evidence from Firm-Level Panel Data

How responsive is business investment to tax policy in Germany? Theoretical work has emphasized the impact on investment behavior through its effect on capital user costs, but evidence for a substantial user cost elasticity is sparse. However, most evidence has been based on aggregate data, and only a few recent studies for the U.S. use firm level data. In this paper we employ firm-level balance sheet data to analyze the nexus between user costs and investment. Using comprehensive panel data provided by the Deutsche Bundesbank, we estimate distributed-lag models and obtain a relatively precise estimate of about -0.42 for the user cost elasticity of investment. Error-correction models do not appear to generate estimates that can be interpreted in a structural way. We use the distributed-lag estimates to assess the prospective impact of tax reform measures in Germany.