Some paradoxical effects of the tax holidays mechanism

Abstract

The paper studies a model for investment stimulating in a project to create a new enterprise under an uncertain economic environment in the framework of the Russian taxation system. It is assumed that the investor can postpone financing the project until a more favorable situation for him. Tax holidays (with fixed duration) are used as a mechanism for attracting investors. When making a decision on financing, investor chooses such an investment moment so that the expected net present value from the implemented project would be maximal. It is shown that the optimal time of investment and the expected net present value from the implemented project depend non-monotonously on the duration of tax holidays. At the same time, the behavior of these indicators is determined by the threshold values of depreciation rate and tax holidays’ duration. It is shown that the range of all possible depreciation rates is divided into three areas, in which each of the above mentioned optimal time of investment and the expected net present value is either a monotone function in terms of tax holidays’ duration, or has one extremum. The worst tax holidays’ period, both from the point of view of investment time and the investor’s expected net present value was established. It is shown that with "reasonable" values of depreciation rates, such worst holidays for the optimal investment moment lie in the range from 3 to 5 years, and for the optimal expected net present value does not exceed 3 years. The sensitivity of these thresholds to varying in project parameters (value added average growth rate, volatility and depreciation rate) is derived.