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The Effect of Tax Convexity on Corporate Investment Decisions and Tax Burdens

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  • SUDIPTO SARKAR
  • LEVON GOUKASIAN

Abstract

This paper examines the effect of convexity in the corporate tax schedule on corporate investment decisions and tax burdens. Using a contingent-claims model, we show that greater tax convexity results in (i) earlier exit, (ii) delayed investment (except for small entry cost), and (iii) reduced corporate risk taking (except for small entry cost and unfavorable operating conditions). Also, the effective tax burden is an increasing function of tax convexity. The convexity of the tax schedule has a nontrivial impact on corporate investment decisions and investment levels. These results are relevant for economic growth, which depends (at least partly) on investment levels, and tax policy makers should be aware of these effects when making adjustments that might impact the convexity of the corporate tax schedule. Copyright 2006 Blackwell Publishing Inc..

Suggested Citation

  • Sudipto Sarkar & Levon Goukasian, 2006. "The Effect of Tax Convexity on Corporate Investment Decisions and Tax Burdens," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 8(2), pages 293-320, May.
  • Handle: RePEc:bla:jpbect:v:8:y:2006:i:2:p:293-320
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    References listed on IDEAS

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    1. Elizabeth M. Caucutt & Selahattin Imrohoroglu & Krishna B. Kumar, 2000. "Does the progressivity of taxes matter for economic growth?," Discussion Paper / Institute for Empirical Macroeconomics 138, Federal Reserve Bank of Minneapolis.
    2. Kevin A. Hassett, 1999. "Tax Policy and Investment," Books, American Enterprise Institute, number 53049.
    3. Saman Majd & Stewart C. Myers, 1985. "Valuing the Government's Tax Claim on Risky Corporate Assets," NBER Working Papers 1553, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Sarkar, Sudipto, 2008. "Can tax convexity be ignored in corporate financing decisions?," Journal of Banking & Finance, Elsevier, vol. 32(7), pages 1310-1321, July.
    2. Agliardi, Elettra & Sereno, Luigi, 2011. "The effects of environmental taxes and quotas on the optimal timing of emission reductions under Choquet–Brownian uncertainty," Economic Modelling, Elsevier, vol. 28(6), pages 2793-2802.
    3. Wong, Kit Pong, 2011. "Progressive taxation and the intensity and timing of investment," Economic Modelling, Elsevier, vol. 28(1-2), pages 100-108, January.
    4. Danielova, Anna & Sarkar, Sudipto, 2011. "The effect of leverage on the tax-cut versus investment-subsidy argument," Review of Financial Economics, Elsevier, vol. 20(4), pages 123-129.
    5. Howard Qi & Sheen Liu & Dean Johnson, 2012. "A model for risky cash flows and tax shields," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 36(4), pages 868-881, October.
    6. Wong, Kit Pong, 2011. "Progressive taxation and the intensity and timing of investment," Economic Modelling, Elsevier, vol. 28(1), pages 100-108.
    7. Schneider, Georg & Sureth, Caren, 2010. "The impact of profit taxation on capitalized investment with options to delay and divest," arqus Discussion Papers in Quantitative Tax Research 97, arqus - Arbeitskreis Quantitative Steuerlehre.
    8. Flavia Barsotti & Maria Elvira Mancino & Monique Pontier, 2011. "Corporate Debt Value with Switching Tax Benefits and Payouts," Working Papers - Mathematical Economics 2011-10, Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa.
    9. Wong, Kit Pong, 2009. "Progressive taxation, tax exemption, and corporate liquidation policy," Economic Modelling, Elsevier, vol. 26(2), pages 295-299, March.

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