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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.

Suggested Citation

  • 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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    References listed on IDEAS

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    Cited by:

    1. Di Corato, Luca & Hess, Sebastian, 2013. "Farmland Investments in Africa: What’s the Deal?," Working Paper Series 2013:10, Swedish University of Agricultural Sciences, Department Economics.
    2. Luca Corato, 2016. "Investment stimuli under government present-biased time preferences," Journal of Economics, Springer, vol. 119(2), pages 101-111, October.
    3. 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.
    4. repec:eee:reveco:v:53:y:2018:i:c:p:151-159 is not listed on IDEAS
    5. Renz, André, 2016. "Die Relevanz von Replikationen in der experimentellen Steuerforschung: Eine Replikationsstudie zu Wahrnehmungsverzerrungen bei Subventionen," arqus Discussion Papers in Quantitative Tax Research 202, arqus - Arbeitskreis Quantitative Steuerlehre.

    More about this item

    Keywords

    Investment incentive; Tax reduction; Investment subsidy; Real option;

    JEL classification:

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

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