Scandinavian Working Papers in Economics

Working Paper Series,
Uppsala University, Department of Economics

No 2000:4: Why is the Corporation Tax Not Neutral? Anticipated Tax Reform, Investment Spurts and Corporate Borrowing

Luis Alvarez JR, Vesa Kanniainen and Jan Södersten ()
Additional contact information
Luis Alvarez JR: Institute of Applied Mathematics, Postal: University of Turku, FIN-20014 Turku, Finland
Vesa Kanniainen: University of Helsinki, Postal: Department of Economics, P.O. Box 54, FIN-00014 University of Helsinki, Finland
Jan Södersten: Department of Economics, Postal: Uppsala University, Box 513, SE-751 20 Uppsala, Sweden

Abstract: The paper shows that a corporate tax policy which is thought to be neutral may have significant incentive effects. This result is established in a model with tax advantage to debt and expectations about a forthcoming tax reform. Investment spurt effects are established and compared to those of a firm with equity finance. A tax-cut cum base-broadening tax reform which leaves the long-run investment incentives of an all-equity firm unaffected is shown to cause a substantial short run investment hike. The findings are illustrated by numerical simulations indicating the magnitudes of the spurt effects.

Keywords: Tax neutrality; Tax reform; Investment spurts; Debt finance

JEL-codes: H25; H32

23 pages, February 15, 2000

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