The effects on investment incentives of an allowance for corporate equity tax system: the Belgian case as an example

Abstract

In the past years, allowance for corporate equity (ACE) tax systems have become more popular even though they are still quite rare. An ACE tends to make a tax system neutral in respect of whether a company is financed by debt or equity. Less attention is given to the effects on investment incentives by scientific literature. We construct a model based on the principle of a hurdle rate to show whether and how an ACE system could change a company’s decision between distribution and reinvestment. The analysis is extended by implementing the so called fairness tax. We find that the influence of the fairness tax on (re)investment incentives depends on the debt to total capital ratio and the return on equity. Hence, the introduction of an ACE does only in certain cases lead to a change from distribution to reinvestment. Interestingly, the fairness tax can increase the incentive to reinvest in few situations and can make the ACE system more attractive in respect of reinvestment.