Scandinavian Working Papers in Economics

Memorandum,
Oslo University, Department of Economics

No 13/2005: An analytical model of required returns to equity under taxation with imperfect loss offset

Diderik Lund ()
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Diderik Lund: Dept. of Economics, University of Oslo, Postal: Department of Economics, University of Oslo, P.O Box 1095 Blindern, N-0317 Oslo, Norway

Abstract: Lund (2002a) showed in a CAPM-type model how tax depreciation schedules affect required expected returns after taxes. Even without leverage higher tax rates implied lower betas when tax deductions were risk free. Here they are risky, and marginal investment is taxed together with inframarginal in an analytical model of decreasing returns. With imperfect loss offset tax claims are analogous to call options. The beta of equity is still decreasing in the tax rate, but increasing in the underlying volatility. The results are important if market data are used to infer required expected returns, and in discussions of tax design.

Keywords: Corporate tax; depreciation; imperfect loss offset; cost of capital; uncertainty

JEL-codes: F23; G31; H25

42 pages, May 15, 2005

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Published as
Diderik Lund, (2014), 'How taxes on firms reduce the risk of after-tax cash flows', FinanzArchiv/Public Finance Analysis, pages 567-598

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