A Note on the Efficient Design of Investment Incentives

10 Pages Posted: 8 Mar 2001 Last revised: 9 Jan 2002

See all articles by Alan J. Auerbach

Alan J. Auerbach

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Date Written: June 1980

Abstract

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.

Suggested Citation

Auerbach, Alan Jeffrey, A Note on the Efficient Design of Investment Incentives (June 1980). NBER Working Paper No. w0483. Available at SSRN: https://ssrn.com/abstract=262705

Alan Jeffrey Auerbach (Contact Author)

University of California, Berkeley - Department of Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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

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Germany

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