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Attracting private investment: Tax reduction, investment subsidy, or both?

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  • Sarkar, Sudipto
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    Abstract

    This paper uses a real-option model to examine the net benefit to a government from using tax cut and/or investment subsidy as incentives to induce immediate investment. Although earlier papers generally concluded that investment subsidy dominates tax cut, it is observed that many governments use a combination of subsidy and tax cut. We show that, when the government uses a different discount rate from private firms, and when it has to borrow money to provide an investment subsidy, it is possible to get an internal optimum; that is, it might be optimal for the government to provide an investment subsidy as well as charge a positive tax rate on the profits from the project. Thus, we provide an explanation for the puzzling fact that many governments provide an investment subsidy to a firm while simultaneously taxing its profits.

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    Bibliographic Info

    Article provided by Elsevier in its journal Economic Modelling.

    Volume (Year): 29 (2012)
    Issue (Month): 5 ()
    Pages: 1780-1785

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    Handle: RePEc:eee:ecmode:v:29:y:2012:i:5:p:1780-1785

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    Web page: http://www.elsevier.com/locate/inca/30411

    Related research

    Keywords: Investment incentive; Tax reduction; Investment subsidy; Real option;

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    References

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    1. Pennings, Enrico, 2000. "Taxes and stimuli of investment under uncertainty," European Economic Review, Elsevier, vol. 44(2), pages 383-391, February.
    2. Richard Cantor & Frank Packer, 1996. "Determinants and impact of sovereign credit ratings," Economic Policy Review, Federal Reserve Bank of New York, issue Oct, pages 37-53.
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    8. Dani Rodrik, 1989. "Policy Uncertainty and Private Investment in Developing Countries," NBER Working Papers 2999, National Bureau of Economic Research, Inc.
    9. Baum, Seth D., 2009. "Description, prescription and the choice of discount rates," Ecological Economics, Elsevier, vol. 69(1), pages 197-205, November.
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    11. Yu, Chia-Feng & Chang, Ta-Cheng & Fan, Chinn-Ping, 2007. "FDI timing: Entry cost subsidy versus tax rate reduction," Economic Modelling, Elsevier, vol. 24(2), pages 262-271, March.
    12. Chang Woon Nam & Doina Maria Radulescu, 2004. "Types of Tax Concessions for Attracting Foreign Direct Investment in Free Economic Zones," ERSA conference papers ersa04p174, European Regional Science Association.
    13. Morrisset, Jacques & Pirnia, Neda, 2000. "How tax policy and incentives affect foreign direct investment - a review," Policy Research Working Paper Series 2509, The World Bank.
    14. Clemens Fuest & Bernd Huber, 1998. "Why Do Countries Subsidize Investment and Not Employment?," NBER Working Papers 6685, National Bureau of Economic Research, Inc.
    15. Lind, Robert C., 1990. "Reassessing the government's discount rate policy in light of new theory and data in a world economy with a high degree of capital mobility," Journal of Environmental Economics and Management, Elsevier, vol. 18(2), pages S8-S28, March.
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    Cited by:
    1. Di Corato, Luca, 2014. "Investment stimuli under government present-biased time preferences," Working Paper Series 2014:3, Department Economics, Swedish University of Agricultural Sciences.

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