Rent taxation when cost monitoring is imperfect

While rent taxation in some theories is neutral, and the tax rate could be set to 100% to minimise the need for distortionary taxes, this does not occur in practice. An important reason for this is the transfer incentives that would result. When cost transfers can only be imperfectly monitored, it is optimal under some conditions to combine a tax on gross revenue with a rent tax. This contributes to explaining the frequent occurrence of gross revenue taxation in actual rent tax systems, and the frequently observed tailoring of rent tax systems in response to output price changes.