Progressive Income Taxes, Tax-Favoured Investments and Investment Behaviour

The current debate on the taxation of business income highlights the need for the tax to not distort investment decisions. A tax on business income that permits immediate expensing of all outlays (including investment outlays) is shown to be a tax on pure profits, whereas a true income tax that allows the write-off of economic depreciation (Samuelson tax) is shown to be a tax on both pure profits and the ‘normal’ interest earned on investments. Neither tax distorts investment decisions, though the latter distorts consumption/investment decisions.Under existing progressive income taxes, which roughly approximate the Samuelson type of tax but which provide tax-concessions to favoured investment activities, pre-tax rates of return on the favoured investment activities will tend toward equilibrium levels below those for non-favoured investments. The tax-favoured investment areas eventually will be dominated by high tax-bracket investors.