An Adverse Effect of an Anticipated Tax Change : Investment Runs in Competitive Equilibrium

In competitive industries, foreseeable policy changes lead to inevitable runs which increase the volatility of investment. We show that this phenomenon, well-known in the case of production caps, also applies to taxes, and occurs whether policy changes apply to new entrants only or equally to all firms. Looking at the case of raising taxes (or removing a subsidy) we find that the size of runs increases with the magnitude of the tax, and that runs are smaller when the policy change affects all firms. Runs accelerate investment compared with the socially optimal path, lowering welfare, and can be quantitatively important. These results have implications for a broad range of policies, such as the removal of renewable energy subsidies in some European countries