The Perverse Effect of Debt Tax Benefits on Firm Investment Decisions

Authors

  • William Addessi,

    1. Department of Economics and Law, University of Rome “La Sapienza”, via del Castro Laurenziano 9, 00161 Rome, Italy. E-mail: w.addessi@gmail.com
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  • Enrico Saltari

    Corresponding author
    1. Department of Economics and Law, University of Rome “La Sapienza”, via del Castro Laurenziano 9, 00161 Rome, Italy. E-mail: w.addessi@gmail.com
      Department of Economics and Law, University of Rome “La Sapienza”, via del Castro Laurenziano 9, 00161 Rome, Italy. Tel: +39 06 49766213. Fax: +39 06 4462040. E-mail: Enrico.Saltari@uniroma1.it
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Department of Economics and Law, University of Rome “La Sapienza”, via del Castro Laurenziano 9, 00161 Rome, Italy. Tel: +39 06 49766213. Fax: +39 06 4462040. E-mail: Enrico.Saltari@uniroma1.it

Abstract

In this paper we question the idea that the deduction of debt interest is always an effective policy instrument to spur firm investment. We analyse the investment decision in presence of a borrowing constraint on the amount of debt that the firm can raise. We show that if the debt interest rate is decreasing in the firm's capital accumulation and another financial resource more expensive than debt is available (at least for levels of debt lower than the upper bound), then the deduction of the debt interest from taxes on capital income may reduce firm investment. This theoretical result is relevant for economic policy decisions when financial intermediaries are not willing to finance beyond a certain threshold but firms have access to other sources of finance.

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