Does Capital Tax Uncertainty Delay Irreversible Risky Investment?

Rainer Niemann, Caren Sureth-Sloane

Publication: Working/Discussion PaperWU Working Paper

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Tax uncertainty is often claimed to be harmful for investments. Capital taxes, such as
property and wealth taxes, are particularly exposed to tax uncertainty. Capital tax un-
certainty emerges from expected tax reforms, the unclear outcome of future tax audits,
and simplified estimates of capital tax bases in investment models. Uncertain returns on
investment as well as stochastic taxation contribute to overall uncertainty and may significantly affect investment decisions. Hitherto, it is unknown how capital tax uncertainty
affects investment timing. However, it is well known that both uncertainty and capital tax
may be harmful for investment and decelerate investment activities. We are the first to
study the investment timing effects of stochastic capital taxes in a real options setting with
risky investment opportunities. Our results indicate that even risk neutral investors are
sensitive with respect to capital tax risk and may react in a surprising manner to a newly
introduced stochastic capital tax. As an apparently paradoxical investment e¤ect, we find
that increased capital tax uncertainty can accelerate risky investment if such uncertainty
is such ciently low compared to cash flow uncertainty. In contrast, high capital tax risk
delays high-risk innovative investment projects. To reduce unintended consequences of
uncertain tax policy, tax legislators and tax authorities should avoid high levels of cap-
ital tax uncertainty. Broadening the capital tax base or increasing the capital tax rate
induces ambiguous timing effects. Furthermore, high-growth investments are likely to
be postponed if they experience a capital tax cut. Since investment reactions upon tax
reforms are well-known to affect income and wealth distribution, reliable estimations of
the impact of taxes on economic decisions are necessary. (authors' abstract)
Original languageEnglish
Place of PublicationVienna
PublisherWU Vienna University of Economics and Business
Publication statusPublished - 2016

Publication series

SeriesWU International Taxation Research Paper Series

WU Working Paper Series

  • WU International Taxation Research Paper Series

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