Skip to content
Licensed Unlicensed Requires Authentication Published by De Gruyter Oldenbourg August 27, 2016

Determinants of Business Fixed Investment: Evidence from German Firm-Level Data

  • Thiess Buettner EMAIL logo and Anja Hoenig

Abstract

This paper employs a novel firm-level dataset that combines financial accounts of German firms with data from a business survey to shed new light on the demand for capital. The empirical analysis employs firm-specific indicators in order to explore the effects of sales, the cost of capital and indicators of the business climate, which are used by the ifo Institute to provide a leading indicator for the German economy. The empirical results support a robust significant effect of a firm’s cost of capital on the stock of capital with an elasticity not significantly different from –1. Controlling for sales, a good rather than normal business situation is found to be associated with about 8 % higher investment.

JEL Classification: H25; E220; E320

Acknowledgements

For comments on an earlier draft we are indebted to two anonymous referees, Martin Falk, Simon Loretz, Joachim Winter, and participants at conferences and seminars in Uppsala, Munich, and Mannheim. All errors remain the authors’ sole responsibility.

Appendix

6.1 Corporate tax parameters in Germany

During the period 1994–2007 corporations were subject to various income taxes, namely the corporate income tax (τc), the business tax on income and capital (τGSt), and the “solidarity surcharge”, τSS. To calculate the statutory tax rate τ for equation (5), we include all three components and account for their interaction. The local business tax rate varies at the level of municipalities, whereas the corporate tax and the solidarity surcharge are the same for all firms and do only vary over time. [16]

Table 8 displays the tax parameters for the cost of capital calculations. Besides the headline rates on retained earnings (and distributed profits until 2000 shown in brackets), we report the solidarity surcharge and the average business tax in our sample for each year. The latter is calculated as an unweighted average of the business tax rates of all municipalities in period t.

Table 8:

Parameters used for tax indicators.

Year Corporate tax rate retained (distributed) profits in % (τc) Solidarity surcharge in % (τSS) Business tax in %, average (τGSt)
1994 45.0 (30.0) 0 15.94
1995 45.0 (30.0) 7.5 15.95
1996 45.0 (30.0) 7.5 16.17
1997 45.0 (30.0) 7.5 16.30
1998 45.0 (30.0) 5.5 16.41
1999 40.0 (30.0) 5.5 16.45
2000 40.0 (30.0) 5.5 16.17
2001 25.0 5.5 16.40
2002 25.0 5.5 16.20
2003 26.5 5.5 16.00
2004 25.0 5.5 15.91
2005 25.0 5.5 15.99
2006 25.0 5.5 16.01
2007 25.0 5.5 16.13
[8]
Table 9:

Records per firm.

Number of years Number of firms Percentage
14 46 7.76
13 12 2.02
12 10 1.69
11 10 1.69
10 26 4.38
9 19 3.20
8 21 3.54
7 30 5.06
6 42 7.08
5 48 8.09
4 89 15.01
3 119 20.07
2 121 20.40
Total 593 100

Source: Number of firms with no missing values in the number of years indicated.

Tax rates on corporate income declined substantially during the period 1994–2007. Moreover, there was a major change in the tax law with the full imputation and split rate system being replaced in 2001 by the so-called half-income system (Tax Relief Act 2001). This implied the replacement of two corporate tax rates – one on retained earnings (τc,RE which varied between 45 % and 40 %) and one on distributed profits (τc,D, of 30%) – by a lower, uniform tax rate of τc=25%. [17]

6.2 Cost of capital and the firms’ capital and asset structures

6.2.1 Cost of capital and the firm’s capital structure

To account for the fact that firms not only use internal funds, but also external funds in the form of debt, we assume that each firm has a specific target value for the share of debt. This target value will presumably be based on incentive considerations, since debt payments constitute a business expense that shields revenues from taxes. Let us denote the target level with λ. Then, if deviating from this target value is costly, optimal investment finance will weight the tax-advantage from using more debt against the cost associated with distorting the capital structure (e. g., Huizinga et al. 2008). For simplicity, one might assume that the cost of deviating from the optimal mix of financing with debt and retained earnings is very high. With this assumption, an investment project will be financed usually with a ratio of debt to capital that is consistent with each firm’s target level λ. If the cost of deviating from the preferred capital structure is less than prohibitive, the actual share of debt used to finance the investment is determined by a function Λλ,Θ that is increasing in the firm’s preferred debt-to-capital ratio λ as well as in the cost advantage of using debt, denoted with Θ (derived below). Obviously, this function will be time-varying since each firm’s target level and cost advantage of debt will change over time.

Then, with a share Λ of investment being financed with debt and only a share 1Λ being financed with retained earnings, the cost of capital will differ from the base case analyzed before. Following Devereux (2004), the derivation of the cost of capital with debt finance is the same, except that we consider an increase in revenues during the investment period and a respective decline in the subsequent period as debt is being repaid. Thus, with a share of debt finance Λ, we need to take account of an increase in revenues equal to Λ1τφ, with 1τφ being the effective price of a unit of investment. In the second period, debt obligations are served and repaid. Hence, profits are reduced by 1+1τr1τφΛ. Taking these additional effects into account, we can thus specify the cost of capital cocΛ for a given share of debt finance as

[6] cocΛcocΛ1τφrτ1τΘ,

where Θ is the difference between the cost of capital using retained earnings and debt finance. This term simply captures the reduction in the cost of capital which arises from the deductibility of interest payments.

6.2.2 Cost of capital and the firm’s asset structure

To further determine the cost of capital for a specific firm, we calculate tax-depreciation allowances for each firm by considering firms’ asset structures. [18] Taking two types of assets into account, namely industrial buildings (IB) and plant/machinery (M) as part of a firm’s fixed assets, we construct weights Ω for each firm, with ΩIB=IBIB+M, ΩM=MIB+M and ΩIB+ΩM=1 (for simplification, the time indices are neglected here). According to these asset shares we calculate firm-specific depreciation rates δ, firm-specific rates of capital allowances ψ and net present values of allowances, A. Specifically, the firm-specific depreciation and capital allowance rates, as well as the net present values of allowances, are calculated according to δ=δIBΩIB+δMΩM, ψ=ψIBΩIB+ψMΩM and A=AIBΩIB+AMΩM.

References

Arellano, M., S. Bond (1991), Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations. The Review of Economic Studies 58: 277–297.Search in Google Scholar

Arellano, M., O. Bover (1995), Another Look at the Instrumental Variable Estimation of Error-Component Models. Journal of Econometrics 68: 29–52.Search in Google Scholar

Becker, S.O., K. Wohlrabe (2008), Micro Data at the Ifo Institute for Economic Research: The Ifo Business Survey, Usage and Access. Journal of Applied Social Science Studies (Schmollers Jahrbuch) 128 (2): 307–319.Search in Google Scholar

Blundell, R., S. Bond (1998), Initial Conditions and Moment Restrictions in Dynamic Panel Data Models. Journal of Econometrics 87: 115–143.Search in Google Scholar

Bond, S. (2002), Dynamic Panel Data Models: A Guide to Micro Data Methods and Practice. Portuguese Economic Journal 1: 141–162.Search in Google Scholar

Bond, S., J. Van Reenen (2007), Chapter 65 Microeconometric Models of Investment and Employment. 4417–4498 in: J.J. Heckman, E.E. Leamer (Eds.), Handbook of Econometrics, Volume 6, Part A. Amsterdam: Elsevier.Search in Google Scholar

Bond, S., J. Xing (2010), Corporate Taxation and Capital Accumulation. Working Paper 1015. Centre for Business Taxation, Oxford University.Search in Google Scholar

Buettner, T., C. Fuest (2010), The Role of the Corporate Income Tax as an Automatic Stabilizer. International Tax and Public Finance 17 (6): 686–698.Search in Google Scholar

Buettner, T., A. Hnig, B. Kauder, M. Krause, N. Potrafke, M. Riem (2016), Rahmenbedingungen fuer private Investitionen in Deutschland, Impuls-Stiftung, Muenchen.Search in Google Scholar

Camacho, M., G. Perez-Quiros (2010), Introducing the Euro-Sting: Short-Term Indicator of Euro Area Growth. Journal of Applied Econometrics 25 (4): 663–694.Search in Google Scholar

Carstensen, K., K. Wohlrabe, C. Ziegler (2011), Predictive Ability of Business Cycle Indicators Under Test: A Case Study for the Euro Area Industrial Production. Jahrbücher für Nationalökonomie und Statistik 231: 82–106.Search in Google Scholar

Chirinko, R.S., S.M. Fazzari, A.P. Meyer (1999), How Responsive is Business Capital Formation to Its User Cost? An Exploration with Micro Data. Journal of Public Economics 74: 53–80.Search in Google Scholar

Chirinko, R.S., S.M. Fazzari, A.P. Meyer (2011), A New Approach to Estimating Production Function Parameters: The Elusive Capital-Labor Substitution Elasticity. Journal of Business and Economic Statistics 29: 587–594.Search in Google Scholar

Cummins, J.G., K.A. Hassett, R.G. Hubbard (1994), A Reconsideration of Investment Behaviour Using Tax Reforms as Natural Experiments. Brookings Papers on Economic Activity 2: 1–74.Search in Google Scholar

Devereux, M.P. (2004), Measuring taxes on income from capital. in: P.B. Sørensen (Ed.), Measuring the Tax Burden on Capital and Labor. MIT Press, Cambridge, Chapter 2.Search in Google Scholar

Devereux, M.P., C. Elschner, D. Endres, J.H. Heckemeyer, M. Overesch, U. Schreiber, C. Spengel (2008), Project for the EU Commission TAXUD/2005/DE/3 10, Final Report. Mannheim, Oxford.Search in Google Scholar

Devereux, M.P., R. Griffith, A. Klemm (2002), Corporate Income Tax Reforms and International Tax Competition. Economic Policy 35: 451–495.Search in Google Scholar

Dwenger, N. (2009), Corporate Taxation and Investment: Explaining Investment Dynamics with Firm-Level Panel Data. Discussion Paper 924, DIW Berlin, German Institute for Economic Research.Search in Google Scholar

Dwenger, N. (2014), User Cost Elasticity of Capital Revisited. Economica 81: 161–186.Search in Google Scholar

Dwenger, N., V. Steiner (2012), Profit Taxation and the Elasticity of the Corporate Income Tax Base. Evidence from German Corporate Tax Return Data. National Tax Journal 65 (1): 117–150.Search in Google Scholar

Dwenger, N., F. Walch (2011), Tax Losses and Firm Investment: Evidence from Tax Statistics. Mimeo.Search in Google Scholar

Egger, P., S. Loretz, M. Pfaffermayr, H. Winner (2009), Firm-Specific Forward-Looking Effective Tax Rates. International Tax and Public Finance 16: 850–870.Search in Google Scholar

Harhoff, D., F. Ramb (2001), Investment and Taxation in Germany – Evidence from Firm-Level Panel Data. 47–73 in: Deutsche Bundesbank (Ed.), Investing Today for the World of Tomorrow – Studies on the Investment Process in Europe, Springer Verlag, Heidelberg.Search in Google Scholar

Hassett, K.A., R.G. Hubbard (2002), Tax Policy and Business Investment. Handbook of Public Economics 3: 1293–1343.Search in Google Scholar

Hoenig, A. (2010), Linkage of Ifo Survey and Balance-Sheet Data: The EBDC Business Expectations Panel & the EBDC Business Investment Panel. Schmollers Jahrbuch 130 (4): 633–642.Search in Google Scholar

Huefner, V.P., M. Schroeder (2002), Forecasting German Industrial Production: An Econometric Comparison of Ifo-and ZEW-Business Expectations. Jahrbücher für Nationalökonomie und Statistik 222 (3): 316–336.Search in Google Scholar

Huizinga, H., L. Laeven, G. Nicodème (2008), Capital Structure and International Debt Shifting. Journal of Financial Economics 88: 80–118.Search in Google Scholar

Nickell, S.J. (1981), Biases in Dynamic Models with Fixed Effects. Econometrica 49 (6): 1417–1426.Search in Google Scholar

Riedel, N. (2010), The Downside of Formula Apportionment: Evidence on Factor Demand Distortions. International Tax and Public Finance 17: 236–258.Search in Google Scholar

Smolny, W., Schneeweis, T. (1999), Innovation, wachstum und beschäftigung: Eine empirische untersuchung auf der basis des Ifo unternehmenspanels. Jahrbücher für Nationalökonomie und Statistik 3 (4): 453–472.Search in Google Scholar

Windmeijer, F. (2005), A Finite Sample Correction for the Variance of Linear Efficient Two-Step GMM Estimators. Journal of Econometrics 126: 25–51.Search in Google Scholar

Winker, P. (1999), Causes and Effects of Financing Constraints at the Firm Level. Small Business Economics 12 (2): 169–181.Search in Google Scholar

Yoo, K. (2003), Corporate Taxation of Foreign Direct Investment Income 1991–2001. OECD Economics Department Working Papers No. 365, OECD Publishing.Search in Google Scholar

Received: 2015-3-6
Revised: 2016-2-13
Accepted: 2016-4-27
Published Online: 2016-8-27
Published in Print: 2016-10-1

©2016 by De Gruyter Mouton

Downloaded on 28.3.2024 from https://www.degruyter.com/document/doi/10.1515/jbnst-2015-1027/html
Scroll to top button