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A Note on the Efficient Design of Investment Incentives

Listed author(s):
  • Alan J. Auerbach

In a recent article in this Journal, Robin Boadway has argued that the appropriate requirement for neutrality is that the present value of the returns from an initial investment of [1pound], using the social discount rate, should be equal for all projects undertaken at the margin. We have few qualifications about this approach itself; although discounting with the social rate of time preference (STP) may be inappropriate in the current context. However, we would take issue with two aspects of Boadwav's application of his view of neutrality. The first problem concerns the appropriate definition of the constraint on firm leverage which would arise from the existence of limited liability. We believe Boadway's assumption to be inappropriate, and find that its replacement with what we argue to be the correct one leads to important revisions in evaluating the neutrality of different incentives. Another point we would make is that Boadway's results depend crucially on the absence of both personal taxes and inflation. We argue below that once realistic account has been taken of these important elements of the problem, general results about the neutrality of different incentives can no longer be derived, so that while Boadway's criterion may be appropriate, its application promises to be very difficult.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0483.

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Date of creation: Jun 1980
Publication status: published as Auerbach, Alan J. "A Note on the Efficient Design of Investment Incentives." The Economic Journal, Vol. 91, (March 1981), pp. 217-223.
Handle: RePEc:nbr:nberwo:0483
Note: PE
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  1. Boadway, Robin W, 1978. "Investment Incentives, Corporate Taxation, and Efficiency in the Allocation of Capital," Economic Journal, Royal Economic Society, vol. 88(351), pages 470-481, September.
  2. Auerbach, Alan J, 1979. "Inflation and the Choice of Asset Life," Journal of Political Economy, University of Chicago Press, vol. 87(3), pages 621-638, June.
  3. Kay, J. A., 1972. "Social discount rates," Journal of Public Economics, Elsevier, vol. 1(3-4), pages 359-378, November.
  4. Sandmo, Agnar, 1974. "Investment Incentives and the Corporate Income Tax," Journal of Political Economy, University of Chicago Press, vol. 82(2), pages 287-302, Part I, M.
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