Question

is it possible that local incentives such as tax credit may have negative effects on firms, especially old firms? How?

Answer 1

Investment allowances and tax credits have both advantages and disadvantages.

They can easily be implemented in a transparent and automatic way, and they are directly contingent on new investment, i.e., the objective of the incentive. However, the advantage of not reducing taxes on existing investments should not be overstated, as this may need lead to an efficient system in the long run. If initially allowances are increased instead of a tax cut, then future tax cuts will be even harder to justify, because they would benefit owners of capital who already enjoyed the high allowances (though it would reduce the value of those allowances still outstanding). As the argument would hold every time cash is available for tax cuts, the system would then evolve further towards a problematic one with a narrow base and a high rate. Moreover, investment allowances will distort the choice of capital towards short-lived goods, because any replacement would again benefit from the allowance/credit. More fundamentally, they will encourage investment in physical rather than financial or human capital, although this is arguably not a disadvantage of this incentive, but possibly of the underlying policy, which is to boost physical investment. If they are not refundable—and typically they are not—they will moreover create a distortion between the investment of new and established businesses, as only the latter will have profits against which to set the allowance or credit.