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Limited Liability, Asymmetric Taxation, and Risk Taking - Why Partial Tax Neutralities can be Harmful

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  • Ralf Ewert
  • Rainer Niemann
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    Abstract

    We examine the combined effects of asymmetric taxation and limited liability on optimal risk taking of investors. Given an optimal risk level in the pre-tax case under full liability, loss-offset restrictions reduce, and limited liability enhances the incentives for taking risk. For every degree of limited liability we can find corresponding loss-offset limitations inducing the same optimal risk level as in the reference case. Thereby we get tax neutrality with respect to risk taking. We show that tax neutrality with respect to risk taking is incompatible with tax neutrality with respect to the choice of the legal form. In our model, full liability requires symmetric taxation and limited liability requires asymmetric taxation of profits and losses.

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    File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2010/wp-cesifo-2010-12/cesifo1_wp3301.pdf
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    Bibliographic Info

    Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3301.

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    Date of creation: 2010
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    Handle: RePEc:ces:ceswps:_3301

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    Related research

    Keywords: limited liability; loss-offset; tax neutrality; risk taking;

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    1. Mackie-Mason, Jeffrey K., 1990. "Some nonlinear tax effects on asset values and investment decisions under uncertainty," Journal of Public Economics, Elsevier, vol. 42(3), pages 301-327, August.
    2. Timothy Guinnane & Ron Harris & Naomi R. Lamoreaux & Jean-Laurent Rosenthal, 2007. "Putting the Corporation in its Place," NBER Working Papers 13109, National Bureau of Economic Research, Inc.
    3. Altshuler, Rosanne & Auerbach, Alan J, 1990. "The Significance of Tax Law Asymmetries: An Empirical Investigation," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 61-86, February.
    4. A. Miglo, 2007. "A note on corporate taxation, limited liability, and asymmetric information," Journal of Economics, Springer, vol. 92(1), pages 11-19, September.
    5. Antonio Estache & Sweder van Wijnbergen, 1999. "Evaluating the Minimum Asset Tax on Corporations: An Option Pricing Approach'," ULB Institutional Repository 2013/44003, ULB -- Universite Libre de Bruxelles.
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    7. Hans-Werner Sinn, 2002. "Risktaking, Limited Liability, and the Competition of Bank Regulators," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 59(3), pages 305-, August.
    8. Eeckhoudt, Louis & Gollier, Christian & Schlesinger, Harris, 1997. "The no-loss offset provision and the attitude towards risk of a risk-neutral firm," Journal of Public Economics, Elsevier, vol. 65(2), pages 207-217, August.
    9. Hemmelgarn, Thomas & Nicodeme, Gaetan, 2010. "The 2008 Financial Crisis and Taxation Policy," CEPR Discussion Papers 7666, C.E.P.R. Discussion Papers.
    10. Eeckhoudt, Louis & Hansen, Pierre, 1982. "Uncertainty and the partial loss offset provision," Economics Letters, Elsevier, vol. 9(1), pages 31-35.
    11. Sinn, Hans-Werner, 1980. "Ökonomische Entscheidungen bei Ungewißheit," Monograph, Mohr Siebeck, Tübingen, edition 1, number urn:isbn:9783169427024, February.
    12. Paolo Panteghini, 2002. "Asymmetric Taxation under Incremental and Sequential Investment," CESifo Working Paper Series 717, CESifo Group Munich.
    13. Johannes Becker & Clemens Fuest, 2007. "Why is there Corporate Taxation? The Role of Limited Liability Revisited," Journal of Economics, Springer, vol. 92(1), pages 1-10, September.
    14. Banerjee, Anindya & Besley, Timothy, 1990. "Moral Hazard, Limited Liability and Taxation: A Principal-Agent Model," Oxford Economic Papers, Oxford University Press, vol. 42(1), pages 46-60, January.
    15. Paolo Panteghini, 2001. "On Corporate Tax Asymmetries and Neutrality," German Economic Review, Verein für Socialpolitik, vol. 2(3), pages 269-286, 08.
    16. Grossman, Richard S, 2001. "Double Liability and Bank Risk Taking," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(2), pages 143-59, May.
    17. Golbe, Devra L., 1988. "Risk-taking by firms near bankruptcy," Economics Letters, Elsevier, vol. 28(1), pages 75-79.
    18. Lund,D., 2000. "Imperfect loss offset and the after-tax expected rate of return to equity, with an application to rent taxation," Memorandum 21/2000, Oslo University, Department of Economics.
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    Cited by:
    1. Rainer Niemann, 2011. "Asymmetric Taxation and Performance-Based Incentive Contracts," CESifo Working Paper Series 3363, CESifo Group Munich.

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