Question

1. Consider a neo-classical investment model with depreciable capital and a corporate income tax system where u is the corporate tax rate, oa is the tax depreciation (CCA) rate, and k is the investment tax credit (ITC) rate. The share of investment financed by debt is B, the economic depreciation rate is 6, the interest rate on debt is i, the required rate of return on equity is ρ, and the price of a unit of output and capital are both normalized to unity There are no adjustment costs, and capital can be instantaneously ad justed to its optimal level. Assume that Canada can be modelled as a small open economy and that for simplicity there is no inflation. The current tax system is characterized by the deduction of nominal debt interest (but not the required return to equity), the deduction of cap- ital cost allowances on a declining balance basis at the rate a, and an investment tax credit which is equal to a fraction k of the total cost of investment (a) Say Canada is considering a tax reform package with the following features o An elimination of the ITC; An increase in the tax depreciation (CCA) rate; . A decrease in the corporate tax rate Discuss generally how each of these changes would individually affect the incentive to invest in corporate capital. Can you tell whether or not investment will increase or decrease as a result of the total tax reform package? Why or why not? (b) Now assume the following iv. The ITC is initially equal to k-10 prior to its elimination v. The tax depreciation (CCA) rate is increased from 20% to 50% vi" The corporate tax rate is decreased from 25% to 15%. Calculate the METR before and after the tax reform package and comment on its impact on inves ment

Answer 1

Solution:

Given that:

  
Girven data A neo - cla ssiceus investment mode :-say canada is con seeing a tax vefrm patkage sth the o ltbwing. * An elimination TC:- Tnuest menl- tux ovedit, wilhep the producer Plan moe nvestment in the Rcaeve 卡 An increase in tex depreciation :- 7 rH means more detrcahon in the tix rate プSimilary adeoreate inthe Coy por ate toxvate encarege ·to invest more anl more, > The deaston op Tue cenada 9overnment change he nvestments of 1ndiv ducs cand Soi praftabe 长. The decese tn the Co-oate ta i Tue Reductton in the CoYporcite 5 vey mpuntant to influence the ven tes eSt oP aphal

囮 ue to -tue overnment deesom ough the el of osca tm th e entu cost of the capit come douon and 1tmeve in Creases tne invesment b Nou asume the follooing C interest-rate) p oyo (shave oP investment) S= 'Lo Cecon crnK depreciation eaton ueTax depreciation Cccaj incY eased 20ytoso mETR

2 = о.to Co.40) + o.loc1-0.49 2(6.10) @.49 .t (o 'lo) (σ. 它 _.lo -3.14, 3olu3.

0-0) 0 . 2.2929 0-20 O 28 S 一 2,5 冫 (o. 128S)-(-3.04) 3. 1695 (27s 12.4.66 ת 2x-45

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