Use it or Lose it: Efficiency Gains from Wealth Taxation

77 Pages Posted: 18 Sep 2019 Last revised: 2 Oct 2019

See all articles by Fatih Guvenen

Fatih Guvenen

University of Minnesota - Department of Economics; National Bureau of Economic Research (NBER)

Gueorgui Kambourov

University of Toronto

Burhanettin Kuruscu

University of Toronto - Department of Economics

Sergio Ocampo-Diaz

University of Minnesota - Twin Cities

Daphne Chen

Econ One Research, Inc.

Date Written: September 2019

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.

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Suggested Citation

Guvenen, Fatih and Kambourov, Gueorgui and Kuruscu, Burhanettin and Ocampo-Diaz, Sergio and Chen, Daphne, Use it or Lose it: Efficiency Gains from Wealth Taxation (September 2019). NBER Working Paper No. w26284. Available at SSRN: https://ssrn.com/abstract=3454385

Fatih Guvenen (Contact Author)

University of Minnesota - Department of Economics ( email )

Minneapolis, MN 55455
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Gueorgui Kambourov

University of Toronto ( email )

Toronto, M5S 3G8
Canada

Burhanettin Kuruscu

University of Toronto - Department of Economics ( email )

Toronto, Ontario M5S 3G8
Canada

HOME PAGE: http://https://sites.google.com/site/bkuruscu

Sergio Ocampo-Diaz

University of Minnesota - Twin Cities ( email )

420 Delaware St. SE
Minneapolis, MN 55455
United States

Daphne Chen

Econ One Research, Inc. ( email )

United States

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