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Taxing Risky Investment

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  • Devereux, Michael P

Abstract

This Paper re-examines the impact of capital income taxes on the incentive to invest in the presence of risk. Specifically, it challenges a well-known claim in the literature that such a tax can leave incentives ‘basically unaffected’ because the tax liability is offset by a reduction in the post-tax risk of the investment. The Paper argues that this claim is based on a misinterpretation of the cost of capital, and that in general the cost of capital is not helpful in assessing investment incentives in the presence of risk. Instead it proposes an alternative measure, based on the market value of the pre-tax stochastic cash flows. This measure indicates that the disincentive effect of capital income taxes can be substantial.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4053.

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Date of creation: Sep 2003
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Handle: RePEc:cpr:ceprdp:4053

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Keywords: capital income tax; investment;

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References

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  1. Fane, G., 1987. "Neutral taxation under uncertainty," Journal of Public Economics, Elsevier, vol. 33(1), pages 95-105, June.
  2. Steve Bond & Michael Devereux, 1999. "Generalised R-based and S-based taxes under uncertainty," IFS Working Papers W99/09, Institute for Fiscal Studies.
  3. Hubbard, R Glenn, 1997. "How Different Are Income and Consumption Taxes?," American Economic Review, American Economic Association, vol. 87(2), pages 138-42, May.
  4. Gordon, Roger H, 1985. "Taxation of Corporate Capital Income: Tax Revenues versus Tax Distortions," The Quarterly Journal of Economics, MIT Press, vol. 100(1), pages 1-27, February.
  5. Louis Kaplow, 1991. "Taxation and Risk Taking: A General Equilibrium Perspective," NBER Working Papers 3709, National Bureau of Economic Research, Inc.
  6. Stiglitz, Joseph E, 1969. "The Effects of Income, Wealth, and Capital Gains Taxation on Risk-Taking," The Quarterly Journal of Economics, MIT Press, vol. 83(2), pages 263-83, May.
  7. Kaplow, Louis, 1994. "Taxation and Risk Taking: A General Equilibrium Perspective," National Tax Journal, National Tax Association, vol. 47(4), pages 789-98, December.
  8. Bulow, Jeremy I & Summers, Lawrence H, 1984. "The Taxation of Risky Assets," Journal of Political Economy, University of Chicago Press, vol. 92(1), pages 20-39, February.
  9. Bonds, Stephen R. & Devereux, Michael P., 1995. "On the design of a neutral business tax under uncertainty," Journal of Public Economics, Elsevier, vol. 58(1), pages 57-71, September.
  10. Gordon, Roger H & Wilson, John Douglas, 1989. "Measuring the Efficiency Cost of Taxing Risky Capital Income," American Economic Review, American Economic Association, vol. 79(3), pages 427-39, June.
  11. Robin Boadway & Neil Bruce, 1982. "A General Proposition on the Design of a Neutral Business Tax," Working Papers 461, Queen's University, Department of Economics.
  12. Diderik Lund, 2002. "Taxation, Uncertainty, and the Cost of Equity," International Tax and Public Finance, Springer, vol. 9(4), pages 483-503, August.
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Cited by:
  1. Panteghini, Paolo M., 2006. "S-based taxation under default risk," Journal of Public Economics, Elsevier, vol. 90(10-11), pages 1923-1937, November.
  2. Michael Devereux, 2003. "Measuring taxes on income from capital," IFS Working Papers W03/04, Institute for Fiscal Studies.
  3. Ruud Mooij & Michael Devereux, 2011. "An applied analysis of ACE and CBIT reforms in the EU," International Tax and Public Finance, Springer, vol. 18(1), pages 93-120, February.

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