Incidence and efficiency aspects of differential taxation of residential and industrial capital in a growing economy

Abstract

This paper demonstrates that a compensated tax on income from residential capital would increase the steady-state capital intensity in the industrial sector of the economy. Consequently, the wage would rise and the gross-of-tax rate of return to capital in the industrial sector would fall. The price of housing services may change in either direction. Secondly, it is shown that maximization of steady-state welfare requires different tax rates on income from residential and non-residential capital. It is demonstrated that if the gross-of-tax rate of return to capital in the industrial sector exceeds the population growth rate, a compensated tax on residential capital or a compensated subsidy on non-residential capital would enhance the steady-state level of welfare. Conversely, if the rate of population growth is greater than the gross-of-tax rate of return to capital in the industrial sector, non-residential capital should be taxed and residential capital should be subsidized.