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Attracting private investment: Tax reduction, investment subsidy, or both?

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  • Sarkar, Sudipto

Abstract

This paper uses a real-option model to examine the net benefit to a government from using tax cut and/or investment subsidy as incentives to induce immediate investment. Although earlier papers generally concluded that investment subsidy dominates tax cut, it is observed that many governments use a combination of subsidy and tax cut. We show that, when the government uses a different discount rate from private firms, and when it has to borrow money to provide an investment subsidy, it is possible to get an internal optimum; that is, it might be optimal for the government to provide an investment subsidy as well as charge a positive tax rate on the profits from the project. Thus, we provide an explanation for the puzzling fact that many governments provide an investment subsidy to a firm while simultaneously taxing its profits.

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  • Sarkar, Sudipto, 2012. "Attracting private investment: Tax reduction, investment subsidy, or both?," Economic Modelling, Elsevier, vol. 29(5), pages 1780-1785.
    • Handle: RePEc:eee:ecmode:v:29:y:2012:i:5:p:1780-1785
    DOI: 10.1016/j.econmod.2012.05.030
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    3. Tan, Yingxian & Pan, Zhihao & Wang, Rui & Wen, Chunhui, 2023. "Macroeconomic conditions and investment stimuli," The North American Journal of Economics and Finance, Elsevier, vol. 67(C).
    4. Aneta Bobenič Hintošová & František Sudzina & Terézia Barlašová, 2021. "Direct and Indirect Effects of Investment Incentives in Slovakia," JRFM, MDPI, vol. 14(2), pages 1-12, February.
    5. Aneta Hintošová & Terézia Barlašová, 2021. "The Role Of Investment Promotion Policy In Attracting Foreign Direct Investment: The Case Of Slovakia," Public administration issues, Higher School of Economics, issue 5, pages 27-40.
    6. Lukas, Elmar & Thiergart, Sascha, 2019. "The interaction of debt financing, cash grants and the optimal investment policy under uncertainty," European Journal of Operational Research, Elsevier, vol. 276(1), pages 284-299.
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    8. Barbosa, Diogo & Carvalho, Vitor M. & Pereira, Paulo J., 2016. "Public stimulus for private investment: An extended real options model," Economic Modelling, Elsevier, vol. 52(PB), pages 742-748.
    9. Kai Chang & Ning Lu & Ze Sheng Li & Yi Ran Wang, 2021. "The combined impacts of fiscal and credit policies on green firm's investment opportunity: Evidences from Chinese firm‐level analysis," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 42(7), pages 1822-1835, October.
    10. Yingjie Niu & Jinqiang Yang & Siqi Zhao, 2022. "Robust stimulus of private investment: Tax rate cut or investment subsidy?," International Journal of Economic Theory, The International Society for Economic Theory, vol. 18(3), pages 339-357, September.
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    14. Nagy, Roel L.G. & Fleten, Stein-Erik & Sendstad, Lars H., 2023. "Don’t stop me now: Incremental capacity growth under subsidy termination risk," Energy Policy, Elsevier, vol. 172(C).
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    16. Azevedo, Alcino & Pereira, Paulo J. & Rodrigues, Artur, 2021. "Optimal timing and capacity choice with taxes and subsidies under uncertainty," Omega, Elsevier, vol. 102(C).
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    More about this item

    Keywords

    Investment incentive; Tax reduction; Investment subsidy; Real option;
    All these keywords.

    JEL classification:

    • H2 - Public Economics - - Taxation, Subsidies, and Revenue

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