The corporate investment response to the domestic production activities deduction

The paper examines how corporate investment responds to the Domestic Production Activities Deduction, a U.S. federal tax regulation that is currently the third largest U.S. corporate tax expenditure. The deduction effectively lowers the corporate tax rate on manufacturing income by 3.15 percentage points. To study the impact of the deduction, plausibly exogenous variation created by the interaction of industry-level manufacturing activity and the phase-in of the policy is exploited. Results indicate investment by publicly traded firms increased by approximately 7% once the deduction was fully implemented. Further analysis suggests this strong response is, at least in part, driven by the interaction of the deduction and another concurrent incentive, the 2004 tax holiday on repatriated foreign earnings.