Effect of Taxation on the Investment Decision in Firms - Research Paper Example

The government dishes out sops to specific sectors and fulfills its task of generating enough growth in high risk sectors. The investment decision of firms depends upon various factors like the political will and stability, the infrastructure and the tax regime. The taxes levied on corporate investments also have a direct bearing on the profitability of these firms; hence they become a vital factor while taking any investment decisions. This therefore makes tax rates an important instrument with governments who manipulate it to ensure economic growth of a country.

This paper examines the effect of taxes on investment decisions of the firms. It explains the various factors that affect firms functioning in the high risk taking sectors and the various instruments available with the government by which they can assist these firms to attain a better economic growth both for the firms and the country. In the end a case study of the steps taken to promote investments in the European Union amplifies the points made in the paper. The profits that a firm earns are directly affected by the rate of taxes that are levied on its produce.

This has a bearing on its investment capacity. The poor infrastructure and institutional facilities combined with high tax rates can make any country a poor investment destination for firms. The tax system is an effective tool in the hands of the government to encourage those sectors which require investments of long gestational periods or poorly developed sectors where there is a need of capital investment. By altering the tax rates governments can shift the investments from more lucrative to high risk sectors by giving cuts in corporate tax and accelerated depreciation so as to increase the post tax profitability of the firm.

This will lead to long run growth of the business as well as the economy. The effects of the proposed tax cuts like the capital gain tax, import duty exemption or local indirect taxes should be measured in relation to the expenditure change that they can offset. Such reductions in tax rates increase the firm's investment capability. Lower taxes help to reap a higher profit by the firms. The role of the governmentThe government hands out large incentives to firms that are keen to invest in high risk sectors but which are good for the overall growth of the country.

These sops can be in the form of tax holidays, import duty exemptions, exemption from custom duties etc. The firm's investment decision is greatly influenced by these tax exemptions. Other major factors that also affect the investments are the political and economic stability of the nation, infrastructure facilities, transport system, roads etc. These factors have an important bearing as they make the environment more conducive for investment, tax rebates are important but cannot be the sole incentive for investment.

Especially in the case of MNC and FDI, studies reveal that the investors are mostly influenced by the market, political factors and tax rebates which are being offered. The government attracts foreign investment in targeted high risk