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Integrating Income Taxes into Finance

In: Business Taxation and Financial Decisions

Author

Listed:
  • Deborah Schanz

    (Chair of Taxation and Accounting)

  • Sebastian Schanz

    (University of Magdeburg)

Abstract

Investment decisions may be wrong when they are made without taking taxes into account. In this chapter, we present the well-known Standard Model. The Standard Model is a simple investment model that integrates income taxes. The previous chapter deals with various investment criteria before taxes; now, we present different investment decision criteria extended by taxes. Using the Standard Model we explain why taxes distort investment decisions. In this context, we explain the income tax paradox which describes increasing after-tax net present values due to taxes. The reason for this distortion can be found in three effects: The tax rate effect, the tax base effect, and the timing effect. Furthermore, we define marginal tax rates and average tax rates. Due to nonlinearity of typical individual income tax rate functions, they differ from each other. Depending on the type of the decision, the marginal or the average tax rate needs to be calculated. At the end of the chapter, we extend the Fisher–Hirshleifer Model from the previous chapter by integrating taxes.

Suggested Citation

  • Deborah Schanz & Sebastian Schanz, 2011. "Integrating Income Taxes into Finance," Springer Books, in: Business Taxation and Financial Decisions, chapter 0, pages 79-135, Springer.
    • Handle: RePEc:spr:sprchp:978-3-642-03284-4_3
    DOI: 10.1007/978-3-642-03284-4_3
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