Effective tax rates and the user cost of capital when interest rates are low

- Capital user cost and ETRs are regularly used to test for tax-investment effects.
- At low interest rates the two measures are not monotonically related.
- This feature can generate perverse estimates of tax-investment effects.

Interest rates are a key component of both user cost and effective tax rate measures of company taxation, and each is regularly used in empirical tests of tax impacts on investment. However, it is shown that when interest rates are low the two measures are not monotonically related. Using a simulated sample of observations, this feature is found to generate perverse estimates of the effects of taxation on the investment plans of firms.