Capital Composition Changes: Effects of Changing Haig-Simons Income Tax Rates

Abstract

This article investigates changes in capital stock composition that are caused by Abstract changing statutory tax rates in a pure Haig-Simons net income tax. Such a tax system allows the deduction of economic depreciation. An increase in the statutory tax rate results in an increase in the effective tax rate, which in turn leads to a decrease in the demand for capital services and, eventually, a contraction of the capital stock. This contraction results in an increase in the marginal product of capital and the related pretax return to physical capital. Increasing pretax returns impact differently on the user cost of long-lived assets relative to that for short lived assets. At equilibrium, following the tax increase, there will be relatively fewer durable assets. In general, such compositional shifts are optimal responses to a second-best situation; in certain instances, however, such shifts are inefficient.