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Adjustment costs and the neutrality of income taxes

  • Matt Benge
  • George Fane

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    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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    File URL: https://crawford.anu.edu.au/acde/publications/publish/papers/wp2006/wp-econ-2006-04.pdf
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    Paper provided by The Australian National University, Arndt-Corden Department of Economics 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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    1. Green, Jerry & Sheshinski, Eytan, 1978. "Optimal Capital-Gains Taxation Under Limited Information," Scholarly Articles 3210340, Harvard University Department of Economics.
    2. Hartman, Richard, 1978. "Investment Neutrality of Business Income Taxes," The Quarterly Journal of Economics, MIT Press, vol. 92(2), pages 245-60, May.
    3. 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.
    4. 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.
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