Optimal timing and capacity choice with taxes and subsidies under uncertainty

Alcino Azevedo*, Paulo J. Pereira, Artur Rodrigues

*Corresponding author for this work

Research output: Contribution to journalArticle

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.

Original languageEnglish
Article number102312
JournalOmega (United Kingdom)
Early online date25 Jul 2020
DOIs
Publication statusE-pub ahead of print - 25 Jul 2020

Bibliographical note

© 2020, Elsevier. Licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International http://creativecommons.org/licenses/by-nc-nd/4.0/

Keywords

  • Capacity choice
  • Investment subsidy
  • Real options
  • Taxation policy
  • Uncertainty

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