Use It or Lose It: Efficiency and Redistributional Effects of Wealth Taxation

Abstract

How does wealth taxation differ from capital income taxation? When the return on investment is equal across individuals, a well-known result is that the two tax systems are equivalent. Motivated by recent empirical evidence documenting persistent heterogeneity in rates of return across individuals, we revisit this question. With such heterogeneity, the two tax systems have opposite implications for both efficiency and inequality. Under capital income taxation, entrepreneurs who are more productive, and therefore generate more income, pay higher taxes. Under wealth taxation, entrepreneurs who have similar wealth levels pay similar taxes regardless of their productivity, which expands the tax base, shifts the tax burden toward unproductive entrepreneurs, and raises the savings rate of productive ones. This reallocation increases aggregate productivity and output. In the simulated model parameterized to match the US data, replacing the capital income tax with a wealth tax in a revenue-neutral fashion delivers a significantly higher average lifetime utility to a newborn (about 7.5% in consumption-equivalent terms). Turning to optimal taxation, the optimal wealth tax (OWT) in a stationary equilibrium is positive and yields even larger welfare gains. In contrast, the optimal capital income tax (OCIT) is negative-a subsidy-and large, and it delivers lower welfare gains than the wealth tax. Furthermore, the subsidy policy increases consumption inequality, whereas the wealth tax reduces it slightly. We also consider an extension that models the transition path and find that individuals who are alive at the time of the policy change, on average, would incur large welfare losses if the new policy is OCIT but would experience large welfare gains if the new policy is an OWT. We conclude that wealth taxation has the potential to raise productivity while simultaneously reducing consumption inequality.

Heterogeneous Agents Dynamic Spatial General Equilibrium

“…These sources of risk are not new to the literature but a much larger body of work in heterogeneous agents models with incomplete markets models focuses on earnings risks. Some notable exceptions are the works by Angeletos (2007), Moll (2014) and Guvenen, Kambourov, Kuruscu, and Ocampo (2022), who develop incomplete markets models with idiosyncratic capital-income risk. Empirically, fluctuations in capital-income over time for the same individual and large differences in the level of capital income across individuals are a prevalent feature of the data.…”

“…See, for example,Angeletos (2007),Moll (2014) andGuvenen et al (2022). In addition,Benhabib et al (2011) develops a tractable incomplete markets model with both stochastic labor and capital income processes.9 Since shocks ϵ a,e ℓ ν are i.i.d., I omit the time subscript.…”