Optimal Tax Depreciation Under a Progressive Tax System

Abstract

The focus of this paper is on the e ect of a progressive tax system on optimal tax depreciation. By using dynamic optimization we show that an optimal strategy exists, and we provide an analytical expression for the optimal depreciation charges. Depreciation charges initially decrease over time, and after a number of periods the firm enters a steady state where depreciation is constant and equal to replacement investments. This way, the optimal solution trades of the benefits of accelerated depreciation (because of discounting) and of constant depreciation (because of the progressive tax system). We show that the steady state will be reached sooner when the initial tax base is lower or when the discounting effect is stronger.

Keywords: tax depreciation, progressive tax system, discounting, dynamic optimization, path coupling.