Investment Effects of Capital Gains Taxation Under Simultaneous Investment and Abandonment Flexibility

Arqus Working Quantitative Tax Research Discussion Paper No. 77

45 Pages Posted: 12 Aug 2012

See all articles by Rainer Niemann

Rainer Niemann

University of Graz, Center for Accounting Research; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Caren Sureth-Sloane

Paderborn University; Vienna University of Economics and Business; TRR 266 Accounting for Transparency

Date Written: May 1, 2009

Abstract

The influence of capital gains taxes on investment decisions is a central issue of accounting and public finance research. However, the implications of capital gains taxes on investors' willingness to invest in irreversible projects with entry and exit flexibility have not yet been a focal issue. As a result, the effects of taxing capital gains on the interdependencies of investment and divestment decisions have to be identified, especially under timing flexibility. This paper closes this gap by simultaneously analyzing investment timing and abandonment decisions for risky irreversible investment projects with uncertain cash flows under differential tax rates for ordinary income and capital gains. We investigate whether capital gains taxes affect immediate and delayed investment asymmetrically. Furthermore, we investigate the impact of capital gains taxation on the optimal abandonment decision. Performing extensive numerical simulations we find that varying the liquidation proceeds affects the decision whether or not to postpone the investment decision. Higher cash flow volatility favors delayed investment. We find that the introduction of capital gains taxation tends to be harmful for immediate investment. Moreover, we show that taxing capital gains may induce a tax paradox for delayed investment. Depending on the pre-tax parameter setting the future value of delayed investment may even increase in absolute terms for increasing capital gains tax rates. For sufficiently high liquidation proceeds capital gains taxation tends to favor continuation of a project. We find taxing capital gains mainly induces other, but not necessarily less arbitrary distortions than exempting capital gains.

Keywords: capital gains tax, investment decisions, real options, tax paradox, timing flexibility, uncertainty

JEL Classification: H25, H21

Suggested Citation

Niemann, Rainer and Sureth-Sloane, Caren, Investment Effects of Capital Gains Taxation Under Simultaneous Investment and Abandonment Flexibility (May 1, 2009). Arqus Working Quantitative Tax Research Discussion Paper No. 77, Available at SSRN: https://ssrn.com/abstract=2128098 or http://dx.doi.org/10.2139/ssrn.2128098

Rainer Niemann

University of Graz, Center for Accounting Research ( email )

Universitätsstr. 15 / G2
Graz, 8010
Austria
+43-316-380-6444 (Phone)
+43-316-380-9595 (Fax)

HOME PAGE: http://www.uni-graz.at/steuer

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

Caren Sureth-Sloane (Contact Author)

Paderborn University ( email )

Warburger Str. 100
Paderborn, 33098
Germany

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020
Austria

TRR 266 Accounting for Transparency ( email )

Warburger Straße 100
Paderborn, 33098
Germany

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
74
Abstract Views
1,086
rank
406,621
PlumX Metrics