Effects of taxes and age on depreciation : the case of combine harvesters

Abstract

Economic depreciation of the total capital stock of a physical asset is determined by the flow of services used in productive activities and by the size of the capital stock. Previous research studies have attempted to analyze economic depreciation by modeling the flow of services. These studies have often failed to fully specify the model by not including important asset specific explanatory variables, and their models were often estimated with restricted functional forms, which implicitly limited the pattern of economic depreciation. This study, on the other hand, uses a flexible functional form which models price as an exponential quadratic function of age, and thus allows the pattern of economic depreciation to be dervied within the model. The behavior of used asset prices are also estimated as an explicit dynamic process which permits a stronger statistical test of the results. In examining the economic depreciation of combine harvesters, this study utilizes specific explanatory variables to account for the effects of changes in the tax code, shocks in demand, and quality and technology differences across combine harvester models. The major empirical results of this study state that depreciation rates are not constant across different ages of combine harvesters and that depreciation rates and patterns are not stable with respect to changes in tax codes. These results present evidence that if further examination of either economic depreciation or optimal replacement problems are to be solved in an internally consistent manner, a more flexible functional form of the used asset price equation must be utilized such as the flexible funtional form used in this study, and changes in the tax code must be included as a specific explanatory variable.