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Consequences of taxation on corporate financial structure and real investments: Empirical analyses

Awarded: NOK 2.3 mill.

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2008 - 2010

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A prominent advantage of the 2006 tax reform is its neutrality with respect to marginal investment decisions, regardless of the preferred choice of financing, combined with a rather high average tax rate caused by double taxation. The investment neutralit y property is due to two features of the new tax structure: First, double taxation only applies to returns in excess of the risk free rate. Second, double taxation applies to capital gains as well as dividend and bond yields (exceeding the risk free rate) . Although theoretically well-founded, it remains an open question how the new tax system will affect business investments and tax revenues. The impact of the tax reform on investments through the cost of capital will depend on the tax planning opportun ities and how the taxpayers respond. If successful, the tax reform will lead to an increase in the tax burden on corporate equity owned by Norwegian citizens, but also increase the relative attractiveness of tax-favored real asset such as owner-occupied h ousing, holiday homes and luxury consumption capital. In particular, small and closely held corporations may find it advantageous to postpone dividends and invest in real assets that provide substitutes for dividends in the form of consumption. The reduce d after-tax yield on stocks may lead domestic investors to choose a different composition of their asset portfolios, with a lesser share of stocks and a higher share of tax-favored real assets. This may lead to an increase in the cost of equity for non-li sted companies, because the cost of capital for these firms are not fully determined in international capital markets. This research proposal focus on the consequences on investments of taxation rules by carrying out empirical analyses in two specific areas: (i) Consequences for financial structure, tax revenue, and the cost of equity, and (ii) the impact on investments in fixed capital

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