Wealth, Returns, and Taxation: A Tale of Two Dependencies

Abstract

We study wealth redistribution in an incomplete markets framework with heterogeneity in returns to wealth arising from type dependence, which reflects heterogeneous investment skills, and scale dependence, which captures that wealth itself triggers investment and associated returns. We analytically show that the macroeconomic implications of wealth taxation depend on four statistics: the wealth Pareto tail, the degree of type and scale dependence, and the extent to which return heterogeneity reflects differences in investment productivity rather than rent-extraction. In a dynamic quantitative model, the US welfare maximizing marginal wealth tax rate is 0.8 percent above an exemption of $550K. Two opposing forces drive the result. Under scale dependence, a wealth tax decreases high return capital investments. Under type-dependence, a wealth tax reinforces the selection of skilled investors at the top which increases the share of high return investments. When return heterogeneity reflects capital productivity differences, only type-dependence provides a rationale for a positive wealth tax. Finally, if returns to wealth partially reflect rents, the optimal wealth tax rate is roughly insensitive as both forces offset each other.

Keywords: Wealth Taxation, Return Heterogeneity, Type and Scale Dependence, Inequality.

JEL Classification: E21, E22, E61, H23