Analytics of Timber Supply and Forest Taxation under Endogenous Credit Rationing — Separability after All

In his celebrated essay, Paul Samuelson defined the “heroic” assumptions of perfect foresight and perfect capital and land markets, under which the harvesting decision is separable from forest owners’ preferences, and under which the Faustmann rotation model offers an adequate model of harvesting behavior. By exogenously assuming the existence of imperfect capital markets, some analysts have concluded that the separability, Faustmann analysis and conventional wisdom about forest taxation is not valid under imperfect capital markets. In this paper credit rationing is endogenized to analyze the harvesting behavior of nonindustrial private forest owners and the effects of forest taxation on timber supply in a two-period model. It turns out that, contrary to exogenous credit rationing models, the cutting decision is separable from the forest owner’s preferences under endogenous credit rationing. The liquidity effects of forest taxes are also absent undermining the ceteris paribus effects derived in exogenous credit rationing models. The paper defines the preferable tax base subject to the government budget constraint in terms of harvesting incentives and derives the optimal forest tax design in terms of the welfare of forest owners. It is shown that, under credit rationing, it is optimal to introduce yield tax at the margin even though the land productivity tax has been chosen optimally. The optimal yield tax rate is greater than zero but less than 100%, which differs from the perfect capital market case, where the 100% yield tax rate is optimal.