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Progressive Taxation and Irreversible Investment under Uncertainty

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  • Luis H. R. Alvarez
  • Erkki Koskela

Abstract

We analyze the impact of progressive taxation on irreversible investment under uncertainty. We show that if tax exemption is lower than sunk cost, higher tax rate will decelerate optimal investment by increasing the optimal investment threshold, while if tax exemption exceeds sunk cost, three different regimes arise. For "small" volatilities the optimal investment threshold is a positive function of volatility, but independent of tax rate. For "medium" volatilities it is independent of both tax rate and volatility. Finally, for "high" volatilities the optimal investment threshold depends positively on volatility, but negatively on tax rate so that we have "tax paradox".

Suggested Citation

  • Luis H. R. Alvarez & Erkki Koskela, 2005. "Progressive Taxation and Irreversible Investment under Uncertainty," CESifo Working Paper Series 1377, CESifo.
    • Handle: RePEc:ces:ceswps:_1377
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    References listed on IDEAS

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    1. Luis H. R. Alvarez & Erkki Koskela, 2007. "Irreversible Capital Accumulation and Nonlinear Tax Policy: A Note," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 63(1), pages 46-53, March.
    2. Niemann, Rainer, 2007. "Risikoübernahme, Arbeitsanreiz und differenzierende Besteuerung," arqus Discussion Papers in Quantitative Tax Research 28, arqus - Arbeitskreis Quantitative Steuerlehre.

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    Keywords

    irreversible investments under uncertainty; progressive taxation;

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