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The Effect of Tax Convexity on Corporate Investment Decisions and Tax Burdens

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  • SUDIPTO SARKAR
  • LEVON GOUKASIAN

Abstract

This paper examines the effect of convexity in the corporate tax schedule on corporate investment decisions and tax burdens. Using a contingent-claims model, we show that greater tax convexity results in (i) earlier exit, (ii) delayed investment (except for small entry cost), and (iii) reduced corporate risk taking (except for small entry cost and unfavorable operating conditions). Also, the effective tax burden is an increasing function of tax convexity. The convexity of the tax schedule has a nontrivial impact on corporate investment decisions and investment levels. These results are relevant for economic growth, which depends (at least partly) on investment levels, and tax policy makers should be aware of these effects when making adjustments that might impact the convexity of the corporate tax schedule. Copyright 2006 Blackwell Publishing Inc..

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Bibliographic Info

Article provided by Association for Public Economic Theory in its journal Journal of Public Economic Theory.

Volume (Year): 8 (2006)
Issue (Month): 2 (05)
Pages: 293-320

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Handle: RePEc:bla:jpbect:v:8:y:2006:i:2:p:293-320

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Cited by:
  1. Wong, Kit Pong, 2011. "Progressive taxation and the intensity and timing of investment," Economic Modelling, Elsevier, vol. 28(1-2), pages 100-108, January.
  2. Flavia Barsotti & Maria Elvira Mancino & Monique Pontier, 2011. "Corporate Debt Value with Switching Tax Benefits and Payouts," Working Papers - Mathematical Economics 2011-10, Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa.
  3. Schneider, Georg & Sureth, Caren, 2010. "The impact of profit taxation on capitalized investment with options to delay and divest," arqus Discussion Papers in Quantitative Tax Research 97, arqus - Arbeitskreis Quantitative Steuerlehre.
  4. Howard Qi & Sheen Liu & Dean Johnson, 2012. "A model for risky cash flows and tax shields," Journal of Economics and Finance, Springer, vol. 36(4), pages 868-881, October.
  5. Wong, Kit Pong, 2009. "Progressive taxation, tax exemption, and corporate liquidation policy," Economic Modelling, Elsevier, vol. 26(2), pages 295-299, March.
  6. Sarkar, Sudipto, 2008. "Can tax convexity be ignored in corporate financing decisions?," Journal of Banking & Finance, Elsevier, vol. 32(7), pages 1310-1321, July.
  7. Danielova, Anna & Sarkar, Sudipto, 2011. "The effect of leverage on the tax-cut versus investment-subsidy argument," Review of Financial Economics, Elsevier, vol. 20(4), pages 123-129.

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