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The effects of tax-deductible reserves on investment incentives

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  • Kari, Seppo

Abstract

This paper investigates how tax-deductible reserves affect the incentive to invest. We consider two different variants: a periodization reserve (PER), which allows the firm to defer tax payments for a certain number of years, and an investment reserve (IVR), which postpones tax payments but has the particular goal of allowing the firm to finance investments from untaxed funds. The latter is assumed to include a penalty levied if the reserve is not used to cover investment. We find that PER lowers the effective tax rate and produces a smaller reduction in the firm’s cost of capital. The impacts of IVR are more complex. With a low penalty, its effects equal those of PER. In both cases they could be mimicked more easily by a reduction in statutory tax rate. However, with a high penalty and high ceiling for allocations, IVR equals a neutral cash flow tax. Similarly, if the firm distributes maximum dividends (binding dividend constraint), both PER and IVR are investment neutral. These neutrality results only concern investment financed from retained profits.

Suggested Citation

  • Kari, Seppo, 2017. "The effects of tax-deductible reserves on investment incentives," Working Papers 93, VATT Institute for Economic Research.
    • Handle: RePEc:fer:wpaper:93
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    References listed on IDEAS

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    1. Kanniainen, Vesa & Sodersten, Jan, 1995. "The importance of reporting conventions for the theory of corporate taxation," Journal of Public Economics, Elsevier, vol. 57(3), pages 417-430, July.
    2. Giorgia Maffini & Jing Xing & Michael P Devereux, 2016. "The impact of investment incentives: evidence from UK corporation tax returns," Working Papers 1601, Oxford University Centre for Business Taxation.
    3. Giorgia Maffini & Jing Xing & Michael P. Devereux, 2019. "The Impact of Investment Incentives: Evidence from UK Corporation Tax Returns," American Economic Journal: Economic Policy, American Economic Association, vol. 11(3), pages 361-389, August.
    4. Bond, Stephen & Xing, Jing, 2015. "Corporate taxation and capital accumulation: Evidence from sectoral panel data for 14 OECD countries," Journal of Public Economics, Elsevier, vol. 130(C), pages 15-31.
    5. Lindhe, Tobias, 2002. "Methods of Mitigating Double Taxation," Working Paper Series 2002:8, Uppsala University, Department of Economics.
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    More about this item

    Keywords

    corporate taxation; international corporate taxation; investment incentives; Business regulation and international economics; H25; H32;
    All these keywords.

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm

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