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A General Tax Paradox under Uncertainty and Low Growth-Interest Rate Differential
Thomas Gries, University of Paderborn
Ulrich Prior, University of Paderborn
Caren Sureth, University of Paderborn
ABSTRACT. Under uncertainty and irreversibility, real option-based models are widely accepted for assessing investment projects. The existing post-tax analyses do not provide a general analytical description of investor reactions towards profit tax rate changes. This paper sets out to fill part of the void. We implement a simple tax system and focus on risky capital market investment and an option to wait. Asymmetrical tax treatment of risk-free and risky capital market investment causes distortions. We identify analytically general paradoxical settings and furthermore, a whole set of neutral tax rates (tax regimes) that preserve the critical post-tax investment threshold in case of tax rates changes. Identifying normal and paradoxical tax regimes can be regarded as a first step to a generalized description of tax effects under uncertainty. The results may be useful for tax rate discussions and to forecast the impact of tax rate changes on investment activities of specific investment projects.
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