17.5 This problem focuses on the interaction of the corporate profits tax with firms' investment decisions. 17.6

a. Suppose (contrary to fact) that profits were defined for tax purposes as what we have called pure economic profits. How would a tax on such profits affect investment decisions?

b. In fact, profits are defined for tax purposes as pg-wl-depreciation, where depreciation is determined by governmental and industry guidelines that seek to allocate a machine's costs over its "useful" lifetime. If depreciation were equal to actual physical deterioration and if a firm were in long-run competitive equilibrium, how would a tax on ' affect the firm's choice of capital inputs?

c. Given the conditions of part (b), describe how capital usage would be affected by adoption of "accelerated depreciation" policies, which specify depreciation rates in excess of physical deteri- oration early in a machine's life but much lower depreciation rates as the machine ages.

d. Under the conditions of part (c), how might a decrease in the corporate profits tax affect capital usage?