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

Sergio Ocampo, Fatih Guvenen, Gueorgui Kambourov, Burhan Kuruscu and Daphne Chen
Additional contact information
Gueorgui Kambourov: University of Toronto, https://www.economics.utoronto.ca
Burhan Kuruscu: University of Toronto, https://www.economics.utoronto.ca
Daphne Chen: Econ One

No 202214, University of Western Ontario, Departmental Research Report Series from University of Western Ontario, Department of Economics

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 return heterogeneity, we revisit this question. With heterogeneity, the two tax systems typically 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 welfare. Turning to optimal taxation, the optimal wealth tax (OWT) is positive and yields large welfare gains by raising efficiency and lowering inequality. In contrast, the optimal capital income tax (OKIT) is negative—a subsidy—and delivers lower welfare gains than OWT, owing to the welfare losses from higher inequality. Furthermore, when the transition path is considered, the gains from OKIT turn into significant welfare losses for existing cohorts, whereas OWT continues to deliver robust welfare gains. These results suggest that moderate wealth taxation may be a more appealing alternative than capital income taxation, which can be significantly more distorting under return heterogeneity than under the equal-returns assumption.

Keywords: wealth tax; capital income tax; optimal taxation; rate of return heterogeneity; power law models; Pareto tail; wealth inequality (search for similar items in EconPapers)
JEL-codes: E21 E22 E62 H21 (search for similar items in EconPapers)
Date: 2022
New Economics Papers: this item is included in nep-acc, nep-dge, nep-pbe and nep-pub
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Journal Article: Use It or Lose It: Efficiency and Redistributional Effects of Wealth Taxation (2023)
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