Does Capital Tax Uncertainty Delay Irreversible Risky Investment?

39 Pages Posted: 10 Oct 2016

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

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Date Written: August 17, 2016

Abstract

Tax uncertainty is often claimed to be harmful for investments. Capital taxes, such as property and wealth taxes, are particularly exposed to tax uncertainty. Capital tax uncertainty emerges from expected tax reforms, the unclear outcome of future tax audits, and simplified estimates of capital tax bases in investment models. Uncertain returns on investment as well as stochastic taxation contribute to overall uncertainty and may significantly affect investment decisions. Hitherto, it is unknown how capital tax uncertainty affects investment timing. However, it is well known that both uncertainty and capital tax may be harmful for investment and decelerate investment activities. We are the first to study the investment timing effects of stochastic capital taxes in a real options setting with risky investment opportunities. Our results indicate that even risk neutral investors are sensitive with respect to capital tax risk and may react in a surprising manner to a newly introduced stochastic capital tax. As an apparently paradoxical investment effect, we find that increased capital tax uncertainty can accelerate risky investment if such uncertainty is sufficiently low compared to cash flow uncertainty. In contrast, high capital tax risk delays high-risk innovative investment projects. To reduce unintended consequences of uncertain tax policy, tax legislators and tax authorities should avoid high levels of capital tax uncertainty. Broadening the capital tax base or increasing the capital tax rate induces ambiguous timing effects. Furthermore, high-growth investments are likely to be postponed if they experience a capital tax cut. Since investment reactions upon tax reforms are well-known to affect income and wealth distribution, reliable estimations of the impact of taxes on economic decisions are necessary.

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

JEL Classification: H210, H250

Suggested Citation

Niemann, Rainer and Sureth-Sloane, Caren, Does Capital Tax Uncertainty Delay Irreversible Risky Investment? (August 17, 2016). CESifo Working Paper Series No. 6046. Available at SSRN: https://ssrn.com/abstract=2850366

Rainer Niemann (Contact Author)

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

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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