Adjustment costs and the neutrality of income taxes

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Adjustment costs and the neutrality of income taxes

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Matt Benge
George Fane ()

Abstract

A true income tax would not affect asset values or investment decisions for given values of cash flows and pre-tax interest rates (Samuelson, 1964). However, most so-called income taxes do not fully tax capital gains on accrual. This note shows that in the absence of adjustment costs, investment decisions are not distorted by the lack of a comprehensive tax on the capital gains on unimproved land, provided that the depreciation of improvements is allowed as a tax deduction. It also provides the intuition underlying the closely related results of Hartman (1978) and Abel (1983).

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Paper provided by Australian National University, Economics RSPAS in its series Departmental Working Papers with number 2006-04.

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Length: 16 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:pas:papers:2006-04

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Find related papers by JEL classification:
H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

This paper has been announced in the following NEP Reports:

NEP-ALL-2006-02-05 (All new papers)
NEP-PBE-2006-02-05 (Public Economics)
NEP-PUB-2006-02-05 (Public Finance)

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Green, Jerry R & Sheshinski, Eytan, 1978. "Optimal Capital-Gains Taxation under Limited Information," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 1143-58, December. [Downloadable!] (restricted)
Abel, Andrew B, 1983. "Tax Neutrality in the Presence of Adjustment Costs," The Quarterly Journal of Economics, MIT Press, vol. 98(4), pages 705-12, November. [Downloadable!] (restricted)
Paul A. Samuelson, 1964. "Tax Deductibility of Economic Depreciation to Insure Invariant Valuations," Journal of Political Economy, University of Chicago Press, vol. 72, pages 604. [Downloadable!] (restricted)
Hartman, Richard, 1978. "Investment Neutrality of Business Income Taxes," The Quarterly Journal of Economics, MIT Press, vol. 92(2), pages 245-60, May. [Downloadable!] (restricted)

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