Optimal timing and capacity choice with taxes and subsidies under uncertainty. (July 2021)

• Record Type: Journal Article
• Authors: Azevedo, Alcino; Pereira, Paulo J.; Rodrigues, Artur
• Is Part Of: Omega. Volume 102(2021)
• Publication Date: 2021-07
• Subjects: Capacity choice -- Investment subsidy -- Real options -- Taxation policy -- Uncertainty; Management -- Periodicals; 658.4005
• DOI: 10.1016/j.omega.2020.102312
• Languages: English
• ISSNs: 0305-0483

Abstract

Highlights: We study the effect of tax-subsidy policies on the investment size and timing. A higher depreciation rate or subsidy, or a lower tax rate, accelerates investments. A fixed (variable) subsidy induces smaller (larger) size investments. Non-monotonic effects may exist for revenue-neutral packages. A higher tax rate can accelerate investments of a larger scale. Abstract: We develop a real options model that examines the effect of government's subsidies and taxation policy on the timing and size of investments. We find that a higher depreciation rate or subsidy, or a lower tax rate, accelerates investments. The effect of subsidies on the investment size depends on whether the subsidy is fixed or variable: a fixed subsidy induces smaller size investments, whereas a variable subsidy encourages larger size investments. The tax and depreciation rates do not affect the size of the investment. For revenue-neutral incentive packages, the effect of changes in the above variables on the investment timing and size is not necessarily monotonic and it depends on the instrument of the tax-subsidy policy that is used to keep the new policy revenue neutral. There are also economic contexts in which an increase in the tax rate can accelerate investments of a larger scale.