Effect of Taxes on Corporate Investment Decisions (Essay Sample)

Effect of Taxes on Corporate Investment Decisions
A plethora of economic factors influence a firm’s investment decisions, such as market potential, interest rates, inflation, availability of finance, and tax policy. However, tax-related aspects comprise one of the most crucial determinants of what, how, and where a firm invests. Taxes have several distorting impacts on a company’s investment decisions, including raising the cost of capital, the trade-off between debt and equity financing, and the investment location choices of multinational firms.
The cost of capital is a qualifying criterion for the evaluation and acceptability of investment projects. For an investment to be profitable, its marginal revenue should be at least equal to its marginal cost (Koivisto 9). Corporate tax increases the marginal cost of capital, rendering investments less desirable. Additionally, firm-level corporate taxes reduce the amount of earnings retained by the firm, restraining the funding sources for new investments (Koivisto 9).
The different tax treatment of debt and equity impacts the capital structure of companies, which can reduce a firm's investment and growth potential. The interest paid on debt capital is tax deductible, while dividends are not (Ohrn 278). The tax deductibility of interest incentivizes firms to finance investments through debt rather than equity (Ohrn 278; Koivisto 9). High financial leverage weakens the financial position of companies and reduces their investment capability ((Ohrn 279).