Working Paper

A Simple Explanation for the Unfavorable Tax Treatment of Investment Costs

Paolo Panteghini
CESifo, Munich, 2006

CESifo Working Paper No. 1784

The evidence shows that in most countries the present value of depreciation allowances is less than 100% of the cost of capital. In this article we use a real-option model with debt financing, and show that less favorable depreciation allowances are offset by tax benefits arising from debt financing. Allowing partial deduction of capital cost is thus a necessary condition for investment neutrality to hold.

CESifo Category
Public Finance
Keywords: capital structure, irreversibility, real options and taxation
JEL Classification: D920,G330