Tax Policy Expectations and Firm Behavior: Evidence from the 2016 U.S. Election and the Tax Cuts and Jobs Act
61 Pages Posted: 25 Feb 2021 Last revised: 14 Jun 2021
Date Written: June 7, 2021
We examine how tax policy expectations evolve around and shape firm responses to a change in tax policy. Our study is motivated by recent research which suggests that bias arising from unmeasured policy expectations can confound inferences regarding the causal impact of a policy change on firm behavior, leaving the new policy’s effect largely unknown. Using a novel approach to measure firms’ expectations over tax policy and exploiting the periods around the surprise election of Donald Trump, who campaigned heavily on tax reform, and the resulting Tax Cuts and Jobs Act (TCJA), we show that these events materially affect tax policy expectations, sometimes counter to often-used conventional assumptions (e.g., we find that uncertainty over tax policy increases after Trump’s election), and exhibit substantial heterogeneity across firms. These expectations affect firm behavior in two important ways. First, we find that tax policy expectations shape firm investment prior to the passage of the TCJA, suggesting that expectations could confound researchers’ ability to attribute changes in firm behavior to the policy change itself. Second, we show that the tax reform affects firm investment through its impact on expectations over tax policy. Our findings are broadly consistent with tax policy expectations shaping firm behavior, and suggest that it is important to measure and incorporate these expectations into the analysis of tax policy.
Keywords: policy expectations, tax policy, tax reform, investment
JEL Classification: D72, G31, G38, H25
Suggested Citation: Suggested Citation