Causal effects of a tax incentive on SME capital investment

We estimate the causal effects of a tax incentive for specific productivity-enhancing equipment introduced in 2014 for Japanese small and medium-sized enterprises (SMEs). Using firm-level panel data, we find, first, that the introduction of the tax incentive did not on average increase the capital investment rate of SMEs eligible for the tax incentive possibly due to the small number of firms using the incentive. Second, despite this finding, the firms using the tax incentive increased their capital investment rate and improved labor productivity more than the comparable firms holding the stated capital close to but more than the criterion of SMEs did. Third, firms using the tax incentive did not increase capital intensity. Fourth, more financially constrained firms using the tax incentive increased their capital investment rate to a greater degree. These results show that the use of the tax incentive mitigates financial constraints in upgrading capital.