The effect of leverage on the tax-cut versus investment-subsidy argument

Anna Danielova and Sudipto Sarkar

Review of Financial Economics, 2011, vol. 20, issue 4, 123-129

Abstract: Two common methods of attracting corporate investment are investment incentives and tax incentives. It is important to use the two incentives in the correct proportions, otherwise the government will give up too much value in the process of attracting investment. This paper examines the effect of tax cut and investment subsidy on the government's net benefit from a project. Earlier studies concluded that it was optimal to use only investment subsidy and no tax cuts. We show that this is not true when debt financing is possible, and it is generally optimal (from the government's perspective) to use a combination of tax reduction and investment subsidy. The optimal tax rate and optimal investment subsidy are identified and analyzed in the paper. It is shown that using a sub-optimal combination of incentives can result in substantial reduction of benefits for the government.

Keywords: Investment incentive; Tax reduction; Investment subsidy; Real option (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (23)

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Journal Article: The effect of leverage on the tax‐cut versus investment‐subsidy argument (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:revfin:v:20:y:2011:i:4:p:123-129

DOI: 10.1016/j.rfe.2011.10.001

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