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The effect of leverage on the tax‐cut versus investment‐subsidy argument
Author(s) -
Danielova Anna,
Sarkar Sudipto
Publication year - 2011
Publication title -
review of financial economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.347
H-Index - 41
eISSN - 1873-5924
pISSN - 1058-3300
DOI - 10.1016/j.rfe.2011.10.001
Subject(s) - subsidy , economics , investment (military) , leverage (statistics) , incentive , monetary economics , tax incentive , tax credit , debt , microeconomics , ad valorem tax , public economics , tax reform , finance , market economy , machine learning , politics , political science , computer science , law
Two common methods of attracting corporate investment are investment incentives and tax incentives. It is important to use the two incentives in the correct proportions, otherwise the government will give up too much value in the process of attracting investment. This paper examines the effect of tax cut and investment subsidy on the government's net benefit from a project. Earlier studies concluded that it was optimal to use only investment subsidy and no tax cuts. We show that this is not true when debt financing is possible, and it is generally optimal (from the government's perspective) to use a combination of tax reduction and investment subsidy. The optimal tax rate and optimal investment subsidy are identified and analyzed in the paper. It is shown that using a sub‐optimal combination of incentives can result in substantial reduction of benefits for the government.