Tax Depreciation Policy and Investment Theory

Abstract

Abstract : A discussion of tax depreciation policy within the framework of the theory of investment of a firm is presented. It is assumed throughout that it is desirable to impose taxes on business income in such a way that the structure of optimal investment decision rules is not altered by the tax. By way of motivational argument it should be emphasized that the present value theory of investment decisions makes no use of the concept of depreciation as a write-off phenomenon, though it is possible to interpret various approaches to the so- called depreciation problem in terms of this theory. Taxless investment theory treats all receipts and outlays as cash inflows and outflows at the instant received or expended, and seeks to maximize the present worth of this lumpy net cash inflow. Sunk investments enter this stream only to the extent that they contribute to current receipts, current expenses, and provide lump-sum disinvestment receipts through salvage or resale. The capital outlays for sunk investments do not enter the future income stream and do not affect investment decisions.