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Should We Tax Capital Income or Wealth?

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Abstract

We study optimal capital income and wealth taxation in an economy that reproduces the importance of private businesses for output and inequality. If entrepreneurs are subject to collateral constraints, they face heterogeneous rates of return, which generate a meaningful distinction between capital income and wealth taxation. We find that taxing capital income is preferable to taxing wealth because the efficiency gains from wealth taxation are swamped by the redistributional benefits of taxing the profits of richer entrepreneurs. Consequently, the gains from taxing wealth are modest. This conclusion is robust to the planner's preference for redistribution and allowing for nonlinear taxes.

Citation

Boar, Corina, and Virgiliu Midrigan. 2023. "Should We Tax Capital Income or Wealth?" American Economic Review: Insights, 5 (2): 259-74. DOI: 10.1257/aeri.20220192

Additional Materials

JEL Classification

  • D31 Personal Income, Wealth, and Their Distributions
  • H21 Taxation and Subsidies: Efficiency; Optimal Taxation
  • H23 Taxation and Subsidies: Externalities; Redistributive Effects; Environmental Taxes and Subsidies
  • H24 Personal Income and Other Nonbusiness Taxes and Subsidies; includes inheritance and gift taxes
  • H25 Business Taxes and Subsidies including sales and value-added (VAT)
  • K34 Tax Law
  • L26 Entrepreneurship