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Why is the Corporation Tax Not Neutral? Anticipated Tax Reform, Investment Spurts and Corporate Borrowing

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Author Info
Alvarez JR, Luis (Institute of Applied Mathematics)
Kanniainen, Vesa (University of Helsinki)
Södersten, Jan () (Department of Economics)

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Abstract

The paper shows that a corporate tax policy which is thought to be neutral may have significant incentive effects. This result is established in a model with tax advantage to debt and expectations about a forthcoming tax reform. Investment spurt effects are established and compared to those of a firm with equity finance. A tax-cut cum base-broadening tax reform which leaves the long-run investment incentives of an all-equity firm unaffected is shown to cause a substantial short run investment hike. The findings are illustrated by numerical simulations indicating the magnitudes of the spurt effects.

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Publisher Info
Paper provided by Uppsala University, Department of Economics in its series Working Paper Series with number 2000:4.

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Length: 23 pages
Date of creation: 15 Feb 2000
Date of revision:
Publication status: Published in FinanzArchiv, 1999, pages 285-309.
Handle: RePEc:hhs:uunewp:2000_004

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Postal: Department of Economics, Uppsala University, P. O. Box 513, SE-751 20 Uppsala, Sweden
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Fax: + 46 18 471 14 78
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Related research
Keywords: Tax neutrality; Tax reform; Investment spurts; Debt finance;

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Find related papers by JEL classification:
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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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Paul A. Samuelson, 1964. "Tax Deductibility of Economic Depreciation to Insure Invariant Valuations," Journal of Political Economy, University of Chicago Press, vol. 72, pages 604. [Downloadable!] (restricted)
  2. Auerbach, Alan J. & Hassett, Kevin, 1992. "Tax policy and business fixed investment in the United States," Journal of Public Economics, Elsevier, vol. 47(2), pages 141-170, March. [Downloadable!] (restricted)
    Other versions:
  3. Alvarez, L. & Kanniainen, V. & Sodersten, J., 1995. "Theory of Tax-Induced Investment Spurts," Papers 1995-18, Uppsala - Working Paper Series.
  4. Cummins, J.G. & Hassett, K.A. & Hubbard, R.G., 1995. "tax Reforms and Investment: A Cross-Country Comparison," Working Papers 95-28, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
    Other versions:
  5. Vesa Kanniainen & Jan Södersten, . "On Financial Adjustment and Investment Booms: Lessons from Tax Reforms," EPRU Working Paper Series 95-01, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
    Other versions:
  6. King, Mervyn A, 1974. "Taxation and the Cost of Capital," Review of Economic Studies, Blackwell Publishing, vol. 41(1), pages 21-35, January. [Downloadable!] (restricted)
  7. Alan J. Auerbach & James R. Hines Jr., 1988. "Investment Tax Incentives and Frequent Tax Reforms," NBER Working Papers 2492, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Luis H. R. Alvarez & Vesa Kanniainen, 1997. "Valuation of Irreversible Entry Options under Uncertainty and Taxation," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich.
  9. Jorgenson, D.W., 1992. "Tax Reform and the Cost of Capital : An International Comparison," Harvard Institute of Economic Research Working Papers 1621, Harvard - Institute of Economic Research.
  10. King, Mervyn A., 1975. "Taxation, corporate financial policy, and the cost of capital : A comment," Journal of Public Economics, Elsevier, vol. 4(3), pages 271-279, August. [Downloadable!] (restricted)
  11. Sandmo, Agnar, 1979. "A note on the neutrality of the cash flow corporation tax," Economics Letters, Elsevier, vol. 4(2), pages 173-176. [Downloadable!] (restricted)
  12. Hans-Werner Sinn, 1991. "Taxation and the Cost of Capital: The "Old" View, the "New" View and Another View," NBER Working Papers 3501, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  13. Hartman, Richard, 1978. "Investment Neutrality of Business Income Taxes," The Quarterly Journal of Economics, MIT Press, vol. 92(2), pages 245-60, May. [Downloadable!] (restricted)
  14. Stiglitz, Joseph E., 1973. "Taxation, corporate financial policy, and the cost of capital," Journal of Public Economics, Elsevier, vol. 2(1), pages 1-34, February. [Downloadable!] (restricted)
  15. Rainer Niemann, 1999. "Neutral Taxation under Uncertainty - a Real Options Approach," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 56(1), pages 51-, March.
  16. Robson, Mark H., 1989. "Measuring the cost of capital when taxes are changing with foresight," Journal of Public Economics, Elsevier, vol. 40(3), pages 261-292, December. [Downloadable!] (restricted)
  17. Boadway, R. W. & Bruce, N., 1979. "Depreciation and interest deductions and the effect of the corporation income tax on investment," Journal of Public Economics, Elsevier, vol. 11(1), pages 93-105, February. [Downloadable!] (restricted)
  18. 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, vol. 69(1), pages 17-48, July. [Downloadable!] (restricted)
  19. Abel, Andrew B, 1983. "Tax Neutrality in the Presence of Adjustment Costs," The Quarterly Journal of Economics, MIT Press, vol. 98(4), pages 705-12, November. [Downloadable!] (restricted)
  20. Mayer, Colin, 1986. "Corporation Tax, Finance and the Cost of Capital," Review of Economic Studies, Blackwell Publishing, vol. 53(1), pages 93-112, January. [Downloadable!] (restricted)
  21. 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. [Downloadable!] (restricted)
    Other versions:
  22. Auerbach, Alan J, 1989. "Tax Reform and Adjustment Costs: The Impact on Investment and Market Value," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(4), pages 939-62, November. [Downloadable!] (restricted)
    Other versions:
  23. Jason G. Cummins & Trevor S. Harris & Kevin A. Hassett, 1994. "Accounting Standards, Information Flow, and Firm Investment Behavior," NBER Working Papers 4685, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  24. Kanniainen, Vesa & Sodersten, Jan, 1995. "The importance of reporting conventions for the theory of corporate taxation," Journal of Public Economics, Elsevier, vol. 57(3), pages 417-430, July. [Downloadable!] (restricted)
  25. Robert E. Lucas & Jr., 1967. "Adjustment Costs and the Theory of Supply," Journal of Political Economy, University of Chicago Press, vol. 75, pages 321. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Rainer Niemann, 2004. "Tax Rate Uncertainty, Investment Decisions, and Tax Neutrality," Asia-Pacific Financial Markets, Springer, vol. 11(3), pages 265-281, May. [Downloadable!] (restricted)
  2. Seppo Kari & Hanna Karikallio & Jukka Pirttilä, 2008. "Anticipating Tax Change: Evidence from the Finnish Corporate Income Tax Reform of 2005," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
    Other versions:
  3. Luis H. R. Alvarez & Erkki Koskela, 2005. "Progressive Taxation and Irreversible Investment under Uncertainty," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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