The Impact of Differential Capital Income Taxation on the Value of Risky Projects

We analyze the impact of differential capital income taxation on the value of risky investment under irreversibility. Under a uniform tax rate, raising the tax rate can either increase or reduce the value of a risky project. Many countries have introduced a separate flat tax on capital income. In contrast to uniform taxation, differential capital income taxation crowds out risky real investment. This dysfunctional effect can neither be corrected by generous depreciation schedules nor by increasing the flat tax rate. This tax discrimination of risky real investment might have contributed to the current crisis.