Does Capital Tax Uncertainty Delay Irreversible Risky Investment?

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 simpli…ed estimates of capital tax bases in investment models. Uncertain returns on investment as well as stochastic taxation contribute to overall uncertainty and may significantly a¤ect investment decisions. Hitherto, it is unknown how capital tax uncertainty a¤ects 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 …rst to study the investment timing e¤ects 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 e¤ect, we …nd that increased capital tax uncertainty can accelerate risky investment if such uncertainty is su¢ ciently low compared to cash ‡ow 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 e¤ects. 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 a¤ect income and wealth distribution, reliable estimations of the impact of taxes on economic decisions are necessary.JEL classi…cation: H25; H21

The Relation between Tax Complexity and Foreign Direct Investments: Evidence Across Countries

“…This finding also appears to be in line with the expectations and results of some theoretical and experimental studies on tax complexity and tax uncertainty. See Beck and Jung (1989), Slemrod (1989), Boylan and Frischmann (2006), Mills et al (2010), and Niemann and Sureth-Sloane (2016).…”