Estimation of tax rate elasticities of durable assets: utility maximizing approach using the AIDS model

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1988
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Virginia Polytechnic Institute and State University
Abstract

This research originated on the premise that if the response of various tax bases to changes in tax rates is different, local governments can minimize stress on tax bases by placing differential levels of reliance on these tax bases. Therefore, the objective of this research was to estimate and evaluate short-run and long-run, own- and cross-rate elasticities with respect to the following tax bases: real property (commercial, agricultural, and residential), personal property, and machinery and tools.

The analytical model was based on demand theory, and a modified linear approximate Almost Ideal Demand System was used to estimate the elasticities. For the estimation of the long-run elasticities, a partial adjustment model was introduced to the demand system. Data covered 36 counties from Virginia, and covered the period 1981-1985.

The results indicated that in the short-run, the value of commercial property had a negative elastic response, while agricultural property had a positive inelastic response. Machinery and tools and residential property values were not significantly affected, but personal property indicated a negative inelastic response for changes in tax rates. The long-run results indicated that elasticity figures become more elastic for commercial property, agricultural property, and personal property while for machinery and tools there was a significant inelastic negative response.

With reference to cross-rate elasticities, in the short-run, machinery and tools depicted a complementary relationship with all the other tax bases except residential property. Tax rate changes of commercial property had a substitution relationship with agricultural property.

In the long-run, however, machinery and tools were significantly impacted only on tax rate changes on personal property. Changes in the tax rate on machinery and tools had a significant complimentary impact on personal property and commercial property. Agricultural property had a significant substitution effect with respect to all the other tax bases except personal property.

Hence, the results indicate that different tax bases respond differently to tax rate changes, which local governments can utilize to maintain or increase tax revenues while reducing the tax burden on tax bases which are very sensitive to tax rate changes.

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