A note on the taxation of capital income and economic rents

Stephen Bond () and Michael Devereux
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Stephen Bond: Institute for Fiscal Studies and Nuffield College, Oxford

No W95/18, IFS Working Papers from Institute for Fiscal Studies

Abstract: This paper contrasts Samuelson's (1964) definition of "true economic depreciation" with the use of this term that has become standard in the more recent literature on neutral business taxes. Samuelson defined "economic depreciation" to be the change in the economic value of an asset, whilst the more recent literature is concerned with change in the replacement cost value of an asset. Economic values can be higher than replacement cost values where the owner of an asset can use it to earn monopoly profits or economic rents. We show that the properties of certain taxes on income from capital depend crucially on which definition of "true economic depreciation" is permitted as a deduction. In particular, Samuelson's comprehensive income tax has the property of invariant valuation - i.e. the economic value of an asset is the same for taxpayers subject to different tax rates - only when the depreciation deduction is the change in economic value, and not when this is the change in the replacement cost value. A class of business taxes are shown to be neutral - i.e equivalent to lump sum taxes - when either of these depreciation deductions are permitted. However, at the same statutory tax rate, the depreciation deduction based on the change in replacement cost values is shown to raise substantially more revenue for the government.

Date: 1995-01-01
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