The Effect of Taxes on the Retirement of Machinery and Equipment

Abstract

This study extends prior research explaining the role of taxes in investment decisions regarding depreciable business assets. It also assesses whether firms’U.S. alternative minimum tax (AMT) status influenced the level of machinery and equipment retired. The article shows analytically that firms paying the AMT have costs of capital lower than firms paying the regular tax when debt shares (debt-to-asset ratio) in their capital structure were lower than a critical level. Two hypotheses are tested: (a) whether firms that paid the AMT and had debt shares below a critical level retired higher amounts of machinery and equipment than other firms and (b) whether firms that paid the AMT retired lower amounts of machinery and equipment in the period following the modification of the AMT formula in 1989 than in the pre-1990 period. Analysis of COMPUSTAT data froma sample of 95 industrial firms over the 1987-1993period supports both hypotheses.