Diderik Lund

Taxation, Uncertainty, and the Cost of Equity

Traditionally the pre-tax cost of capital is a function of the interest rate and the tax system. However, uncertainty implies that the markets required return is no single interest rate, but depends on risk. Different tax systems split risk differently between firm and government. Thus the required expected return after corporate taxes depends on the tax system. Expressions for this are derived, based on a CAPM-type model. The weighted average cost of capital is decreasing in the tax rate, even for fully equity financed projects. This effect can be substantial, but is neglected in much of the literature.

Rent taxation when cost monitoring is imperfect

While rent taxation in some theories is neutral, and the tax rate could be set to 100% to minimise the need for distortionary taxes, this does not occur in practice. An important reason for this is the transfer incentives that would result. When cost transfers can only be imperfectly monitored, it is optimal under some conditions to combine a tax on gross revenue with a rent tax. This contributes to explaining the frequent occurrence of gross revenue taxation in actual rent tax systems, and the frequently observed tailoring of rent tax systems in response to output price changes.

Can a Small Nation Gain from a Domestic Carbon Tax? The Case with R&D Externalities

Carbon taxes have other effects in addition to their possible impact on global warming. When research and development (R&D) has positive external effects, carbon taxes can help to correct for such effects by providing incentives for R&D in particular directions. If authorities cannot distinguish between different R&D types, the standard corrective subsidies cannot be implemented, thereby creating an additional role for a carbon tax. Copyright 1994 by The editors of the Scandinavian Journal of Economics.

Neutrality of the Resource Super Profits Tax

A report by Hausman claims that the Resource Super Profits Tax proposed in Australia in May 2010 was distortionary because it did not allow deductions when companies exercise real options. This article shows that standard financial theory leads to other conclusions and discusses some other points made by Hausman. The proposed tax system did not necessarily distort the choice to close down an operation with large losses carried forward. However, there could be some transitional problems and the introduction of the system could increase perceived sovereign risk. This must be weighed against adverse effects of other distortionary taxes.

Cream Skimming, Dregs Skimming, and Pooling: On the Dynamics of Competitive Screening

We discuss the existence of a pooling equilibrium in a two-period model of an insurance market with asymmetric information. We solve the model numerically. We pay particular attention to the reasons for non-existence in cases where no pooling equilibrium exists. In addition to the phenomenon of cream skimming emphasized in earlier literature, we here point to the importance of the opposite: dregs skimming, whereby high-risk consumers are profitably detracted from the candidate pooling contract.

Less than single dividend taxation: A note

Abstract The taxation in Norway of corporate and dividend income makes it attractive for individuals in high tax brackets to earn their income through corporations, as dividends. This kind of incentive has been assumed in the literature to be non-existing because of its adverse effects.

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

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.

Comparative statics for real options on oil: What stylized facts to use?

ABSTRACT An important application in the real options literature has been in investments in the oil sector. Two commonly applied “stylized facts” in such applications are tested here. One is that the correlation of the returns on oil and the stock market is positive; the other that it is invariant to changes in oil price volatility. Both are rejected in data for 1993–2008 for crude oil and Standard & Poors 500 stock market index. Based on real options theory, consequences are pointed out. The widespread idea that higher volatility leads to increased value and postponed investment is not necessarily valid.