Wednesday, May 20, 2009

Yes, tax capital income

A long standing result of taxation theory is that the optimal tax rate for capital income is zero. The only exceptions to this are in situations where private decisions lead to capital accumulation that is higher than socially desirable, for example when households self-insure too much in the face of borrowing constraints, or when accumulated capital is treated as a proxy for age and it is optimal to tax older people more.

Juan Carlos Conesa, Sagiri Kitao and Dirk Krueger present another good reason: borrowing constraints and life-cycle cum no age discrimination. Why would this make the lead article in the American Economic Review (after the presidential address)? Maybe because they come up with a high optimal tax rate of 36%, which comes close to reality in many jurisdictions. While I am sounding sarcastic here, this is a good paper with very interesting contributions. While this result is robust to any reasonable change on the calibration, it hinges one some critical modeling features. For example, endogenous labor supply is required, and so is progressivity of labor income tax and, or course, the life cycle. I cannot think of another paper that would have these (reasonable) features and would thus have had any chance of obtaining a significantly positive capital income tax rate.

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