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Optimal Taxation of Wealth

Periodic Reporting for period 1 - Wealth-Taxation (Optimal Taxation of Wealth)

Reporting period: 2017-09-01 to 2018-08-31

Should governments tax income from wealth (capital income) or the wealth stock itself? What would be the optimal mix and structure of different taxes on wealth? These are the main questions that this project addresses.

Growing inequality has been a big concern among academics, policymakers, and the public. Wealth taxation has been proposed as a way to alleviate wealth inequality. For example, Thomas Piketty’s book Capital in the Twenty-First Century put wealth taxation at the centre of public debate. Despite the fact that several countries have used wealth taxes, the rationale for such taxes are often vague – fairness, reducing inequality – and not studied formally. The aim of the project was to study quantitatively the implications of different forms of wealth taxation for wealth inequality, economic efficiency, and overall welfare.
The project analyzed the quantitative implications of wealth tax as opposed to capital income tax in an overlapping-generations incomplete-markets model with rate of return heterogeneity across individuals. With such heterogeneity, capital income and wealth taxes have different efficiency and distributional implications. Under capital income taxation, entrepreneurs who are more productive, and therefore generate more income, pay higher taxes. Under wealth taxation, on the other hand, entrepreneurs who have similar wealth levels pay similar taxes regardless of their productivity, which expands the base and shifts the tax burden toward unproductive entrepreneurs. This reallocation increases aggregate productivity and output. In the simulated model calibrated to the U.S. data, a revenue-neutral tax reform that replaces the capital income tax with a wealth tax raises welfare by about 8% in consumption-equivalent terms. Moving on to optimal taxation, the optimal wealth tax is positive, yields even larger welfare gains than the tax reform, and is preferable to optimal capital income taxes. Interestingly, optimal wealth taxes result in more equal consumption and leisure distributions (despite the wealth distribution becoming more dispersed). Consequently, wealth taxes can yield both efficiency and distributional gains.
A significant progress has been done in finding the optimal taxes on wealth during the course of the Marie Sklodowska Curie fellowship. The project contributes to the debate on wealth taxation by providing a rigorous analysis and guidance to policymakers on how wealth should be taxed. Furthermore, it fills an important gap in the literature on optimal taxation of wealth/capital, which is the lack of a realistic wealth distribution in the quantitative analysis, by developing a realistic model of wealth inequality and using it to find the optimal tax policy on wealth. It shows that having a realistic model of wealth inequality makes a big difference in terms of policy conclusions. While the previous papers which modelled only labour income inequality would find no difference between the taxing the stock of wealth and taxing income from wealth (since they turn out to be equivalent), taxing the stock of wealth is superior to taxing the income from wealth when wealth inequality is generated by capital income heterogeneity as modelled in this project.
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