Academic journal article The American Journal of Economics and Sociology

A Simple General Test for Tax Bias

Academic journal article The American Journal of Economics and Sociology

A Simple General Test for Tax Bias

Article excerpt

The method here is to infer the biasing effects of taxes from their differential effects on present values of rival uses for land. A local tax jurisdiction is an open economy. Our simplifying premise is that arbitrage equalizes all after-tax rates of return on new investing, at levels determined in world capital markets. Labor is free to come and go, and product prices are set in world markets. Given those premises, all taxes are shifted to land, the only factor fixed in an otherwise open economy; tax jurisdictions are defined as fixed areas of land.

Using these premises lets us devise a simple test for tax neutrality. (1) Treat net present value derived from a land improvement as a residual, and impute this residual value to land. Find algebraically the ratio of after-tax land value to before-tax land value. If the ratio is simply (1 - t) (where t is a tax rate), the tax is neutral--the highest and best use of land after tax is the same as that before tax. (2) The ratio (1 - t) is independent of any parameter the landowner controls. The tax base on marginal land must be zero, lest the land be sterilized. (3)

The simplicity of this technique allows for complexity in the applications, without losing any threads in tangles of detail. We can analyze or just inspect many parameters in the ratio to find what specific avoidance maneuvers a tax will induce and to estimate what excess burdens will result. In this paper, we analyze effects on substitution of capital for labor and for land, including effects on capital turnover and frequency of site renewal. We analyze differential effects on different grades or qualities of land. We can also show how to find revenue-neutral tax rates, when tax A is substituted for tax B. We can point toward dangerously snowballing "Laffer-curve effects" and how to minimize them by selecting more neutral kinds of taxes.

The present study uses timber culture as an example because this enables a simple analysis, along with continuous grounding in reality. Timber is a good allegory for all other forms of investment. It occupies 32 percent of the private land area of the nation and is weighty in its own right (Daugherty 1995). This short paper does not treat other kinds of capital explicitly, but does explain a simple means of modifying the analysis to do so. The writer has published the relevant mathematics elsewhere (Gaffney 1976a, esp. Appendix I).

One distinguished commentator, Gordon Tullock, has suggested orally that this is Georgist tax theory restated. He is partly right, partly wrong. The findings are consistent with Henry George's ideas about the neutrality of taxing land values. However, George had no capital theory except an error-ridden one that no one cares to remember, while the present paper deals mostly with durable capital.

I

Harvest or Yield Tax

"YIELD" TAXES ARE IMPOSED on the harvest value of timber ("stumpage"), net of harvest costs, but gross of up-front capital costs. The tax rate is flat, at rate t. The taxable event is timber harvest. Yield taxes are widely believed to be neutral because the growth rate of stumpage after tax is the same as it is before tax. Our analysis is more comprehensive, however, considering the whole investment cycle, and finds a heavy bias. First, we set up the model:

S = site value from discounted cash flow (DCF) absent taxes

R = revenue from "stumpage" (sale value net of harvest costs) at maturity (year "m")

m = maturity (years from planting to harvest)

i = relevant interest and discount rate

t = tax rate applied to the base "R" after m years

P = planting cost, year zero

One may incorporate intermediate costs and revenues in the model without disturbing it, either by compounding them forward to year m (where they are commensurable with "R"), or by discounting them to year zero (where they are commensurable with "P"). …

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