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Progressive Taxation and Irreversible Investment under Uncertainty

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  • Luis H. R. Alvarez
  • Erkki Koskela

Abstract

We analyze the impact of progressive taxation on irreversible investment under uncertainty. We show that if tax exemption is lower than sunk cost, higher tax rate will decelerate optimal investment by increasing the optimal investment threshold, while if tax exemption exceeds sunk cost, three different regimes arise. For "small" volatilities the optimal investment threshold is a positive function of volatility, but independent of tax rate. For "medium" volatilities it is independent of both tax rate and volatility. Finally, for "high" volatilities the optimal investment threshold depends positively on volatility, but negatively on tax rate so that we have "tax paradox".

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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1377.

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Date of creation: 2005
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Handle: RePEc:ces:ceswps:_1377

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Keywords: irreversible investments under uncertainty; progressive taxation;

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References

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  1. Kevin Hassett & Gilbert E. Metcalf, 1994. "Investment with Uncertain Tax Policy: Does Random Tax Policy Discourage Investment?," NBER Working Papers 4780, National Bureau of Economic Research, Inc.
  2. Caren Sureth, 2002. "Partially Irreversible Investment Decisions and Taxation under Uncertainty: A Real Option Approach," German Economic Review, Verein für Socialpolitik, Verein für Socialpolitik, vol. 3(2), pages 185-221, 05.
  3. Paolo Panteghini, 2004. "Wide vs. Narrow Tax Bases under Optimal Investment Timing," CESifo Working Paper Series 1246, CESifo Group Munich.
  4. Lund, D., 1990. "Petroleum Taxation under Uncertainty-Contingent Claims Analysis with an Application to Norway," Memorandum, Oslo University, Department of Economics 24/1990, Oslo University, Department of Economics.
  5. Metcalf, Gilbert E. & Hassett, Kevin A., 1995. "Investment under alternative return assumptions Comparing random walks and mean reversion," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 19(8), pages 1471-1488, November.
  6. Luis Alvarez & Vesa Kanniainen & Jan Södersten, 1999. "Why is the Corporation Tax Not Neutral?. Anticipated Tax Reform, Investment Spurts and Corporate Borrowing," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, Mohr Siebeck, Tübingen, vol. 56(3/4), pages 285-, July.
  7. Pennings, Enrico, 2000. "Taxes and stimuli of investment under uncertainty," European Economic Review, Elsevier, Elsevier, vol. 44(2), pages 383-391, February.
  8. Paolo M. Panteghini, 2001. "Corporate Tax Asymmetries under Investment Irreversibility," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, Mohr Siebeck, Tübingen, vol. 58(3), pages 207-, July.
  9. Alvarez, Luis H.R. & Koskela, Erkki, 2007. "Taxation and rotation age under stochastic forest stand value," Journal of Environmental Economics and Management, Elsevier, vol. 54(1), pages 113-127, July.
  10. Rainer Niemann, 1999. "Neutral Taxation under Uncertainty - a Real Options Approach," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, Mohr Siebeck, Tübingen, vol. 56(1), pages 51-66, March.
  11. Paolo Panteghini, 2002. "Endogenous Timing and the Taxation of Discrete Investment Choices," CESifo Working Paper Series 723, CESifo Group Munich.
  12. Caballero, Ricardo J., 1999. "Aggregate investment," Handbook of Macroeconomics, Elsevier, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 12, pages 813-862 Elsevier.
  13. Niemann, Rainer & Sureth, Caren, 2004. "Tax neutrality under irreversibility and risk aversion," Economics Letters, Elsevier, Elsevier, vol. 84(1), pages 43-47, July.
  14. Bertola, Giuseppe, 1998. "Irreversible investment," Research in Economics, Elsevier, Elsevier, vol. 52(1), pages 3-37, March.
  15. Paolo Panteghini, 2002. "Asymmetric Taxation under Incremental and Sequential Investment," CESifo Working Paper Series 717, CESifo Group Munich.
  16. Paolo Panteghini, 2000. "On Corporate Tax Asymmetries and Neutrality," CESifo Working Paper Series 276, CESifo Group Munich.
  17. Mackie-Mason, Jeffrey K., 1990. "Some nonlinear tax effects on asset values and investment decisions under uncertainty," Journal of Public Economics, Elsevier, Elsevier, vol. 42(3), pages 301-327, August.
  18. Agliardi, Elettra, 2001. "Taxation and Investment Decisions: A Real Options Approach," Australian Economic Papers, Wiley Blackwell, Wiley Blackwell, vol. 40(1), pages 44-55, March.
  19. Alvarez, Luis H. R. & Kanniainen, Vesa & Sodersten, Jan, 1998. "Tax policy uncertainty and corporate investment: A theory of tax-induced investment spurts," Journal of Public Economics, Elsevier, Elsevier, vol. 69(1), pages 17-48, July.
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Cited by:
  1. Niemann, Rainer, 2007. "Risikoübernahme, Arbeitsanreiz und differenzierende Besteuerung," arqus Discussion Papers in Quantitative Tax Research, arqus - Arbeitskreis Quantitative Steuerlehre 28, arqus - Arbeitskreis Quantitative Steuerlehre.

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