A theory of capital gains taxation and business turnover

Abstract

We present a theory concerning the realization of capital gains where ownership and control are linked as in Holmes and Schmitz (J. Pol. Econ. 103: 1005-1038, 1995). The model developed is a version of a Lucas-tree economy in which the productivity of a technology depends on the ownership of the technology. The existence and uniqueness of equilibrium follow from the Contraction Mapping Theorem. The theory implies that impediments to asset trading, such as capital gains taxation, negatively affect production efficiency. Moreover, we calibrate the model economy to U.S. data on small-business turnover and find that indexing deductions for inflation is capable of increasing capital-gains tax revenues.