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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).

Suggested Citation

  • Matt Benge & George Fane, 2006. "Adjustment costs and the neutrality of income taxes," Departmental Working Papers 2006-04, The Australian National University, Arndt-Corden Department of Economics.
    • Handle: RePEc:pas:papers:2006-04
    as

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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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    References listed on IDEAS

    as
    1. Paul A. Samuelson, 1964. "Tax Deductibility of Economic Depreciation to Insure Invariant Valuations," Journal of Political Economy, University of Chicago Press, vol. 72(6), pages 604-604.
    2. Richard Hartman, 1978. "Investment Neutrality of Business Income Taxes," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 92(2), pages 245-260.
    3. 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 1143-1158, December.
    4. Andrew B. Abel, 1983. "Tax Neutrality in the Presence of Adjustment Costs," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 98(4), pages 705-712.
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    More about this item

    Keywords

    Capital gains tax; depreciation; income tax; investment neutrality.;
    All these keywords.

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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