An Income Tax Wedge between Buyers' and Sellers' Values of Forests

Abstract

Although forestry's long production period is seen as a discouragement to reforestation, some economists have noted that selling immature timber for future harvest can shorten the payoff period for the original owner. This paper shows how income taxes may inhibit such sales of immature forests, documenting a type of lock-in effect to date not quantified. Under several types of local government taxes, theoretical curves of willingness to pay for immature even-aged timber have been derived (Klemperer 1976). These models showed that the seller's asking price should equal the buyer's bid, if both parties have the same view of the future, use the same interest rate, and face the same local government taxes. However, income taxes were not included. After income taxes, Kovenock and Rothschild (1983) have shown that, for assets such as aging wine and timber, the asking price will exceed the bid at ages between initial investment and final sale for consumption. This paper derives equations for ask and bid prices for even-aged forests of any age, after income taxes, allowing for inflation and separation of land and timber values. Potential differences between ask and bid are computed, using yield functions for loblolly pine pulpwood and Douglas-fir with a longer sawtimber rotation. Results show that under certain plausible conditions, the mid-rotation asking price for forested properties can be from 30 to over 40 percent above the highest bid when ask and bid are computed to guarantee buyer and seller the same after-tax real rate of return. While these findings are based on restrictive assumptions, the general importance for market decisions is discussed. Relevance of this work can be seen in the unusually large acreage of forested tracts sold or offered prior to harvest date in the early and mid-1980s (Duke University 1984, 1986). Numerous forest products firms sought to reduce their capital investment and improve cash flows, speculating that enough timber would be available on the open market in the future.