We study foreign direct investment agreements that entitle firms to a lower tax rate during a tax holiday period. Our model considers both finite and uncertain tax holiday period settings. We show that the tax holiday duration may have, for small tax rate reductions, a nonmonotonic effect on the investment timing. For sufficiently high tax reductions, a longer tax holiday speeds up investment. A higher tax reduction during the tax holiday and a lower uncertainty are shown to have a monotonic effect on the threshold, hastening investment. However, in case of a finite tax holiday, for exceptional high salvage values, a higher uncer- tainty can speed up investment. We show the usefulness of our model to design an optimal incentives package that prompts investment.
Bibliographical noteThis is the peer reviewed version of the following article: Azevedo A, Pereira PJ, Rodrigues A. Foreign direct investment with tax holidays and policy uncertainty. Int J Fin Econ. 2018;1–13, which has been published in final form at https://doi.org/10.1002/ijfe.1688. This article may be used for non-commercial purposes in accordance With Wiley Terms and Conditions for self-archiving.
Funding: FCT. Grant Numbers: POCI-01-0145-FEDER-006683, POCI-01-0145-FEDER-006890; ERDF