Taxation of Risky Investment and Paradoxical Investor Behavior

Arqus Quantitative Tax Research Discussion Paper No. 26

49 Pages Posted: 3 Dec 2007

See all articles by Thomas Gries

Thomas Gries

University of Paderborn

Ulrich Prior

University of Paderborn - Department of Economics

Caren Sureth-Sloane

Paderborn University; Vienna University of Economics and Business

Date Written: April 2007

Abstract

Under uncertainty and irreversibly, real option-based models are widely accepted for assessing investment projects. So far the existing post-tax analyzes do not provide a general analytical description of investor reactions towards profit tax rate changes. This paper sets out to fill part of the void. We implement a simple tax system and focus on risky capital market investment and an option to wait. Taxes affect risk-free and risky capital market investment asymmetrically and hence cause distortions. We analytically identify a set of neutral tax rates (tax regimes) that preserve the critical post-tax investment threshold in case of tax rate changes as well as general normal and paradoxical settings. Unlike for other tax paradox neither depreciation rules nor loss offset restrictions are responsible for the observed paradoxical reaction. Identifying normal and paradoxical tax regimes can be regarded as a first step to a generalized description of tax effects under uncertainty, both for individual project evaluation as well as for understanding tax effects on an aggregate level.

Keywords: investment decisions, real options, tax paradox, uncertainty

JEL Classification: H25, H21

Suggested Citation

Gries, Thomas and Prior, Ulrich and Sureth-Sloane, Caren, Taxation of Risky Investment and Paradoxical Investor Behavior (April 2007). Arqus Quantitative Tax Research Discussion Paper No. 26, Available at SSRN: https://ssrn.com/abstract=1036701 or http://dx.doi.org/10.2139/ssrn.1036701

Thomas Gries (Contact Author)

University of Paderborn ( email )

Warburger St. 100
Paderborn, D-33098
Germany

Ulrich Prior

University of Paderborn - Department of Economics ( email )

Warburger Str. 100
D-33098 Paderborn
Germany

Caren Sureth-Sloane

Paderborn University ( email )

Warburger Str. 100
Paderborn, 33098
Germany

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020
Austria

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