Barry Eichengreen: Like the 1930s, in Reverse
Department of "Huh?" (Bear Stearns Edition)

Taxing Income from Capital: Utilitarianism-Maoism-Waldmannism Edition

Robert Waldmann has a nice little toy model--an intuition pump--that leads to positively Maoist conclusions: In his model, a benevolent utilitarian government is not only not averse to taxing income from capital but taxes that income at the highest rate possible.

In general, there are two reasons to be leery of taxing income from capital:

  • By essentially taxing the movement of purchasing power forward in time from the present to the future, such a tax tilts individuals' consumption toward the present and away from the future: their consumption does not grow over time as rapidly (or falls over time faster) than is optimal given individual tastes and social production possibilities.

  • The movement of purchasing power from the present to the future is also the process of capital accumulation, and taxing it reduces capital accumulation and so creates an economy with a productive inefficiency: too low a capital-output ratio.

And there are two reasons to be enthusiastic about taxing income from capital:

  • It makes individuals feel poorer and thus--for those whose lifetime consumption is too high relative to the social optimum--leads them to consume less.

  • Already-existing capital is inelastically supplied, and thus can be taxed without imposing any excess-burden deadweight losses at all.

Waldmann presents a model in which (i) the holders of capital are all too rich with too high a level of consumption, hence (ii) you want to tilt their consumption profile so that their consumption declines as fast as possible, and (iii) the capital-output ratio is fixed--hence there are no productive inefficiencies. Thus the optimal government policy is to tax the capital income of the rich as much as possible until they become so poor that their consumption level hits the social optimum value, and use the resources raised to boost the consumption of the poor.

It's a very nice intuition pump. The way I like to think about it is that the problem that Waldmann has set his benevolent utilitarian government is one that is ideally solved via a 100% tax on excessive consumption, and that a capital income tax is good because it is a close approximation to such a 100% excessive consumption tax.