On Optimal Forest Taxation under Timber Price Uncertainty

Working Papers 105 Koskela Erkki

The paper analyzes optimal forest taxation under future timber price uncertainty and perfect capital markets by comparing the welfare properties of lump-sum and yield forest taxes. With risk-averse forest owners the lump-sum tax alone is not efficient; given the optimal lump-sum tax one increase the expected utility forest owners by introducing the yield tax, which at the margin serves as an insurance device by decreasing the post-tax variability of timber revenue. How far this insurance role should be carried out depends on the nature of risk on the one hand and on the government expenditure preferences on the other hand. Under idiosynractic risk the full insurance via the 100 % yield tax is optimal since the yield tax in non-distortionary at the margin under certainty. In the presence of aggregate risk, however, the situation is a bit different. If forest owners are risk-neutral with respect to government expenditures, then the full insurance is still optimal, but if the variability of government expenditures matters, the degree of partial insurance depends on relative strengh of risk toward private vis-a-vis public consumption.