Investment with Uncertain Tax Policy: Does Random Tax Policy Discourage Investment?

The authors consider the impact of tax policy uncertainty on firm level and aggregate investment, comparing investment behavior when uncertainty is due to a shock following geometric Brownian motion (GBM) versus when random discrete jumps in tax policy occur. Expectations of the likelihood of a tax policy switch have an important negative impact on the gain to delaying investment in the latter model and time to investment can fall with increasing tax policy uncertainty. Aggregate investment simulations indicate that capital formation is adversely affected by increases in uncertainty in the traditional GBM model but can be enhanced in the jump process model.