Working Paper: NBER ID: w1924
Authors: Saman Majd; Stewart C. Myers
Abstract: This paper investigates the impact of tax asymmetries (the lack of full loss offsets) under current corporate income tax law and a stylized tax reform proposal. The government's tax claim on the firm's pretax cash flows is modelled as a series of path-dependent call options and valued by option pricing procedures and Monte Carlo simulation.The tax reform investigated reduces the statutory tax rate, eliminates the investment tax credit and sets tax depreciation approximately equal to economic depreciation. These changes would increase the effective tax rate on marginal investments by firms that always pay taxes, but dramatically reduce the potential burden of tax asymmetries. "Stand-alone" investments, which are exposed to the greatest burden, are uniformly more valuable under this reform, despite the loss of the investment tax credit and accelerated depreciation.These general results are backed up by a series of numerical experiments. We vary investment risk, inflation (with and without indexing of tax depreciation), and investigate how allowing interest on loss carry forwards would affect after-tax project value.
Keywords: Corporate Taxation; Tax Asymmetries; Investment Valuation; Tax Reform
JEL Codes: H25; H32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Tax asymmetries (H22) | Aftertax NPVs for high-risk investments (G11) |
| High-risk investments (G11) | Government's tax claim (H26) |
| Stylized tax reform proposal (H29) | Effective tax rate on marginal investments for firms that always pay taxes (H32) |
| Stylized tax reform proposal (H29) | Burden of tax asymmetries on standalone projects (H22) |
| Tax asymmetries (H22) | Distortion of real investment decisions under proposed tax reform (H32) |