Marginal Effective Tax Rates, Tax Incentives and Investment Behavior-Taiwan’s Empirical Study


Author:Keh–Nan Sun and Han-Chin Liu

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Over the past forty years, Taiwan has been one of few countries that have successfully maintained high economic growth. Investment has clearly played a significant role in Taiwan’s economic development with the government endeavoring to improve the investment environment. For example, it enacted the Statue for Encouragement of Investment(SEI)in 1960, and the Statue for Upgrading Industries(SUI)in 1991, as a follow up to the SEI. Those laws offered tax incentives which were intended to stimulate investment. Using the neoclassical theory of firm investment behavior, this study integrates user cost of capital, developed by Jorgenson(1963) and Hall and Jorgenson(1967), marginal effective tax rate(METR)proposed by Auerbach(1983a, b), Fullerton(1984)and King and Fullerton(1984), and considers the portfolio of investment(i.e. debt, equity and retained earnings financed). We set up a formula to estimate METR and to examine the effects of tax incentives on investment. We calculate the user cost of capital and marginal effective tax rates on investment in Taiwan within the manufacturing industry for the period 1956~1997. The major empirical findings are as follows: In general, the user cost of capital decreased due to the increase in tax incentives, marginal effective tax rates then decreased. Lowering the marginal effective tax rates through tax measures could improve investment rates, but the degree of improvement will be different among industries. The stimulated effects on traditional industries which are labor intensive were larger than in the capital intensive or technology-based industries. The policy implication is that tax incentives in the investment-driven stage of economic development are more effective than in the innovation–driven stage. Keywords: Marginal Effective Tax Rate, User Cost of Capital, Tax Incentive.