Capital Income Taxes with Heterogeneous Discount Rates

Abstract

With heterogeneity in both skills and discount factors, the Atkinson-Stiglitz theorem that savings should not be taxed does not hold. We consider a model with heterogeneity of preferences at each earnings level. With some assumptions on the equilibrium, a small savings tax on high earners and a small savings subsidy on low earners both increase welfare, regardless of the correlation between ability and discount factor. Key is that types who value future consumption less are more tempted to switch to a lower paid job. Extending Saez (2002), a uniform savings tax increases welfare if the correlation of skill with discount factor is sufficiently high. Some optimal tax results and empirical evidence to support the assumptions are presented.

Keywords: Optimal Taxation, Capital Income, Discount Rates

JEL Classification: H21