Investigating a thin-capitalization rule: An option-based analysis
AbstractThe Czech tax system is undergoing radical transformation. Among the many forthcoming changes, several features can be identified, which alter the structure of tax asymmetries. This paper uses an option-based model of direct taxation to examine a controversial new thin-capitalization rule, stipulating a mandatory benchmark for deductible unrelated-party loan expenses. We estimate the costs of debt under various risk-related scenarios, focusing on particular situations where the new regulation may result in distortions of business incentives and investment behaviour. We find that the measure can disproportionally increase the marginal cost of debt for companies with relatively risky business profiles. In particular, if the law were followed strictly, it could create effective barriers to further growth under perfectly realistic combinations of leverage and business risk. Another asymmetry arises due to a small-business exemption which can make new investment prohibitive when its cap is being reached. The model also suggests that non-deductibility of interest increases credit risk and could, in the longer term, contribute to a slack in SME lending.
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Bibliographic InfoArticle provided by University of Economics, Prague in its journal Politická ekonomie.
Volume (Year): 2008 (2008)
Issue (Month): 5 ()
Postal: Redakce Politické ekonomie, Vysoká škola ekonomická, nám. W. Churchilla 4, 130 67 Praha 3
Find related papers by JEL classification:
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
- H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm
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