Tax Policy in the Real World by Joel Slemrod

By Joel Slemrod

This quantity collects articles from the Symposium sequence of the nationwide Tax magazine from 1993 to 1998. prime economists and different students talk about and debate present tax coverage concerns in nontechnical language and illustrate how the rules of tax research may be utilized to real-world concerns. one of the themes addressed are the sensible feasibility of intake tax choices to the present source of revenue tax, the explanation and implications of devolution of financial duties to kingdom and native governments, the influence of tax coverage on fiscal development, and the worth of neighborhood tax incentives designed to draw and hold company.

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If capital gains are more lightly taxed, the total tax burden on investment therefore goes down, and hence the cost of capital is reduced when the corporation takes advantage of accelerated depreciation. Monitoring Costs, Dividend Constraints, and the Cost of Capital: The "Nordic" View According to the above analysis, a corporation wishing to minimize its cost of capital will have a tax incentive to exploit deductions for accelerated depreciation to the maximum possible extent. Nevertheless, as Kanniainen and Sodersten (1994b) pointed out, public corporations in Sweden and Finland have consistently failed to exploit all available deductions for depreciation and various reserve funds, even in cases where they might have eliminated their corporate tax liability altogether by doing so.

The old view also assumes that shareholders have a nontax preference for dividends over capital gains on shares. Other things equal, shareholders will thus require a lower after-tax return on shares in corporations with higher dividend pay-out ratios. Up to a point, the corporation is therefore able to reduce its cost of equity finance by raising its pay-out ratio. Since new share issues increase the ability of the corporation to pay dividends to existing shareholders, it becomes optimal for the valuemaximizing corporation' to rely to some extent on new equity rather than using only retained profits as the source of equity finance.

If the various modes of finance are in fact equally attractive from a nontax point of view, it follows that the corporation should rely exclusively on the source of finance that is most favored by the tax system. In most countries, this mode of finance would be debt, because equity-financed investment tends to be subject to double taxation. If debt is used as the marginal source of finance, and taxable profits 30 Peter Birch Sorensen coincide with actual profits, it will be profitable for the corporation to carry its real investment to the point where the risk-adjusted marginal pretax rate of return is just equal to the (deductible) market rate of interest before tax.

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