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Tax Exhaustion, Firm Investment, and Leasing: A Test of the Q Model of Investment

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  • Michael P. O'Malley

Abstract

Standard models of investment usually incorporate various tax factors but often overlook \"tax exhaustion,\" the case when a firm has negative taxable income and cannot claim immediately its tax deductions or credits. However, tax exhausted firms face a higher cost of capital, and evidence shows that tax exhaustion is not uncommon. This paper incorporates tax exhaustion into a \"Q\" model of investment to see whether its performance is improved. In addition, leased investment is fully incorporated into the model, in part because tax exhaustion creates incentives to lease investment products and because investment models explain decisions to use equipment, not the decision about how to finance them. The results show that accounting for leasing improves significantly the performance of the Q model, whereas accounting for tax exhaustion does not affect the results meaningfully.

Suggested Citation

  • Michael P. O'Malley, "undated". "Tax Exhaustion, Firm Investment, and Leasing: A Test of the Q Model of Investment," Finance and Economics Discussion Series 1996-31, Board of Governors of the Federal Reserve System (U.S.), revised 10 Dec 2019.
    • Handle: RePEc:fip:fedgfe:1996-31
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    References listed on IDEAS

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    Keywords

    Investment; corporate taxation; leasing;
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