A Simple Explanation for the Unfavorable Tax Treatment of Investment Costs
17 Pages Posted: 26 Sep 2006
Date Written: August 2006
The evidence shows that in most countries the present value of depreciation allowances is less than 100% of the cost of capital. In this article we use a real-option model with debt financing, and show that less favorable depreciation allowances are offset by tax benefits arising from debt financing. Allowing partial deduction of capital cost is thus a necessary condition for investment neutrality to hold.
Keywords: capital structure, irreversibility, real options and taxation
JEL Classification: D92, G12, G33, H25
Suggested Citation: Suggested Citation