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Capital Decay and Tax Distortions: How to Abandon Exponential Decay and Benefit from It

Listed author(s):
  • Biørn, Erik


    (Dept. of Economics, University of Oslo)

The appropriate way of quantifying how taxation of a firm's income and capital can distort its optimizing conditions is a recurring issue in the literature on optimal taxation. Exponential decay, although empirically contested, is almost ubiquitous. In the present paper a generalized framework which allows for a general, non-exponential, decay pattern for both true and tax-permitted depreciation, is considered. Both convex and concave survival functions can be accommodated. Three capital concepts are involved, two of which coincide under exponential decay. The trade-off between various departures from neutrality is illustrated. Elements which contribute to non-neutrality are: (i) discrepancy between the defnition of the tax-relevant accounting capital and true depreciation, (ii) mis-indexation of depreciation allowances, (iii) incomplete deductibility of interest costs, (iv) asymmetric treatment of interest costs and capital gains, and (v) taxation of the value of the capital stock. Finally, we show that substantial biases can arise in assessing the degree of non-neutrality if non-exponential depreciation schedules are forced, by `approximation devices', to ft into the exponential decay schedule.

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Paper provided by Oslo University, Department of Economics in its series Memorandum with number 27/2009.

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Length: 32 pages
Date of creation: 28 Dec 2009
Handle: RePEc:hhs:osloec:2009_027
Contact details of provider: Postal:
Department of Economics, University of Oslo, P.O Box 1095 Blindern, N-0317 Oslo, Norway

Phone: 22 85 51 27
Fax: 22 85 50 35
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  1. Roger Gordon & Laura Kalambokidis & Joel Slemrod, 2003. "A New Summary Measure of the Effective Tax Rate on Investment," NBER Working Papers 9535, National Bureau of Economic Research, Inc.
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