RDP 2025-01: Are Investment Tax Breaks Effective? Australian Evidence 8. Conclusions

Various tax incentives have been provided to businesses in Australia over the past 15 years, both as a stimulus tool and as a structural tool to raise aggregate investment. Such incentives are inherently costly in fiscal terms, and so it is important to understand whether they are actually effective in stimulating additional investment.

We evaluate seven policies over a twelve-year period using difference in differences and regression discontinuity designs to identify the causal impact of investment tax breaks on firm investment. Our time period covers ‘normal’ economic times, the global financial crisis and the COVID-19 pandemic. This approach of examining a range of policies, at different time periods and in one country allows us to draw conclusions about heterogeneous effects of investment tax breaks free from the problems of poor comparability often found in cross-country studies.

ITBs seem to be somewhat less effective in Australia, compared to many other countries. This appears related to the existence of dividend imputation, which lessens the value of the ITB to company shareholders and means that the policies mainly affect small unincorporated businesses. This is an important insight about the relationship between ITBs and other elements of the design of the overall tax system. Our finding is consistent with the old view of corporate finance, where firms fund themselves externally.

Overall, our results suggest the effectiveness of the policies studied is mixed at best, and probably highly dependent on the nature of the policy and macroeconomic conditions. In Australia, ITB policies as economic stimulus may be most effective during downturns which are driven by a shock to credit supply, rather than a sharp decrease in demand. ITBs appear to loosen cash flow constraints for businesses in periods of credit dislocation. In normal times they seem to have little effect. Policies targeted at smaller firms appear somewhat more effective: unincorporated businesses in particular are far more responsive. Policy uncertainty, reflected in frequent policy changes and uncertainty about the continuation of a policy, may undermine effectiveness.

Finally, while not the main focus of our paper, we do find some evidence that corporate tax rate cuts led to an increase in investment, consistent with theory and previous empirical evidence from cross-country and other studies.