The Taxation of Capital Gains on Land in a Growing Economy

Abstract

Firms employ land, capital, and labour to produce a homogeneous commodity which is used for consumption and investment. Government levies a tax at a flat rate and spends the proceeds on public consumption and public investment. Factor income and capital gains on land, diminished by taxation, form disposable income. Households save a fixed share of disposable income. Savings, in turn, serve to finance both private investment and capital gains on land. This gives rise to a portfolio made up of two assets: Land and capital. Land income consists of land rents and capital gains, whereas capital income consists of interest payments. In equilibrium, land and capital yield the same rate of return after tax. Under the restrictive income tax (excluding capital gains), a tax increase generally raises the land price. Under the comprehensive income tax (including capital gains), a tax increase has no bearing on the land price. Under special land taxes, however, a tax increase lowers the land price.