How Taxes on Firms Reduce the risk of After-Tax Cash Flows

Diderik Lund

Published by FinanzArchiv/Public Finance Analysis, 70(4), 567 - 598, December 2014.

 

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Most firms use one discount rate applied to expected net after-tax cash flows. The need to adjust for differences in risk, other than leverage, is commonly neglected. There can be substantial effects of taxation on after-tax risk when there are depreciation deductions. Among the few studies of these effects, even fewer identify all effects correctly. When marginal investment is taxed together with inframarginal, the marginal beta for the Capital Asset Pricing Model differs from the average. The problems identified here imply that currently suggested tax reforms may fail. Tax neutrality results rely on firms correctly discounting for risk, in particular the risk of tax deductions.

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Published Jan. 15, 2015 4:03 PM - Last modified Apr. 7, 2015 11:09 AM