Essays on the Investment and Tax Revenue Effects of Tax Loss Offset Provisions

Abstract

“Investment is the fundamental source of firm value and economic growth.” (Hanlon and Heitzman, 2010, p. 147) Firms decide on investments based on the expected future cash flows. Since existing tax systems are not decision-neutral, a rational decisionmaker includes tax payments in his decision calculus when choosing between tax-relevant investments. It is not sufficient to only use the statutory tax rate in order to determine the effective tax burden of an investment project. Instead, it is additionally of importance to consider aspects of the tax base. One aspect of the tax system which reduces the after-tax net present value of investments and distorts corporate investment decisions is the asymmetric treatment of profits and losses. While profits are typically taxed in the year of occurrence, firms running a loss do not, in principle, receive an immediate refund. Instead, losses have to be used in previous (loss carryback) or subsequent (loss carryforward) periods. This thesis contributes to the understanding of the effects of asymmetric taxation on corporate investment decisions (procurement of tangible and intangible fixed assets, financial investments in the form of shares in other firms) and states’ tax revenues. The first study (Asymmetric Tax Loss Treatment and Corporate Investment Behavior: An Empirical Investigation using Simulated Marginal Tax Rates) contributes to the question whether and how losses and loss carryforwards affect corporate investment. I document that losses and their offsetting probability have a significant effect on firms’ investment behavior and verify that tax loss carryforwards have contrary effects – they increase investment from a tax perspective in order to achieve tax benefits resulting from offsetting accumulated losses (e.g., Auerbach, 1986) and reduce investment from an economic perspective because of a lack of financial sources for further investment (e.g., Dreßler and Overesch, 2013). The second study of this thesis (Anti-Tax Loss Trafficking Rules and the Acquisition of Loss-Carrying Firms) aims to answer the question of whether acquisitions of loss-carrying firms are reduced due to anti-tax loss trafficking rules and whether the design of restrictions affects the quantity of acquiring loss targets. I show a significant negative effect for the strictness of anti-tax loss trafficking rules on the acquisition rate and number of acquisitions of loss-carrying firms, indicating that the stricter the anti-tax loss trafficking rules the lower the acquisitions of loss targets. Since restrictive loss offset rules generally reduce corporate investment, unrestricted loss offset regulations should be adopted as far as possible in order to not inhibit investment. A way to reform loss offsetting in Europe would be abandoning minimum taxation. Therefore, the aim of the third study (How expensive is the Abolition of Minimum Taxation in Europe? An Estimation of Tax Revenue Consequences) is to estimate the tax revenue consequences which would result from an abolition of minimum taxation in Europe. I find that countries would have to forego 0.44 to 3 percent of their tax revenues. This relative reform effect is equivalent to 5.784 billion Euro for Germany in absolute terms.