Can Tax Rate Increases Foster Investment Under Entry and Exit Flexibility? - Insights from an Economic Experiment

51 Pages Posted: 31 May 2014 Last revised: 24 Jun 2014

See all articles by Rene Fahr

Rene Fahr

University of Paderborn; IZA Institute of Labor Economics

Elmar Janssen

University of Paderborn

Caren Sureth-Sloane

University of Paderborn; Vienna University of Economics and Business

Date Written: 2014

Abstract

It is well-known that taxes affect risky investment decisions. Analytical studies indicate that tax rate increases can foster (accelerate) investment if there is flexibility, in particular when an exit option is available. We design an experiment that is based on an analytical model with binomial random walk and entry and exit flexibility. Contrasting the underlying model, we find accelerated investment, which is often considered as an increased willingness to invest, on tax rate increases to be independent of the existence of an exit option. However, we observe this investor reaction only for a tax increase, not for a tax decrease. This investment behavior is driven possibly by tax salience and the mechanisms known from the theory of irreversible choice under uncertainty. Our empirical evidence suggests that the accelerating tax effects are much more common than is predicted by the theoretical literature. Policy makers should therefore carefully consider the behavioral aspects when anticipating taxpayer reactions.

Keywords: Investment Decisions, Tax Effects, Timing Flexibility, Economic Experiment

JEL Classification: H25, H21, C91

Suggested Citation

Fahr, Rene and Janssen, Elmar and Sureth-Sloane, Caren, Can Tax Rate Increases Foster Investment Under Entry and Exit Flexibility? - Insights from an Economic Experiment (2014). WU International Taxation Research Paper Series No. 2014 - 05. Available at SSRN: https://ssrn.com/abstract=2442721 or http://dx.doi.org/10.2139/ssrn.2442721

Rene Fahr

University of Paderborn ( email )

Warburger Str. 100
D-33098 Paderborn
Germany
+49 5251 60 3692 (Phone)

HOME PAGE: http://www.quantitative-cg.de

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany
+49 228 38 94 0 (Phone)
+49 228 38 94 510 (Fax)

Elmar Janssen

University of Paderborn ( email )

Warburger Str. 100
Paderborn, D-33098
Germany

Caren Sureth-Sloane (Contact Author)

University of Paderborn ( email )

Warburger Str. 100
Paderborn, 33098
Germany

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020
Austria

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