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The Taxation of Capital Income

The Economist of lLondon:

Economics: How should governments tax capital?: Tax reform is again on the political agenda in America and elsewhere. Of particular interest is the way in which capital ought to be taxed. If we assume that income taxes are not going away, what is the best or most appropriate way to tax capital gains and capital and corporate income? What should be taxed, at what level and at what rate (relative to rates on wage income)?

My take:

Economics: Tax luck, not thrift—and do it progressively: WE WANT to tax luck--heavily.

We don't want to tax enterprise and ingenuity.

We do not want to create armies of accountants gaming our system.

In a world that is as a whole still relatively poor we do not want to tax thrift.

And we want to use our tax system to provide a substantial amount of social insurance: if you could ask us all as neonates whether we wanted a lump-sum, a flat, or a progressive tax, we would (if we could think and talk) nearly all call for a strongly progressive tax—and if you could ask us even earlier, before we had drunk from the Lethe when we all still faced the risk that we might not choose the right parents, that conclusion would be squared.

These considerations push in very different directions. The closest to a point of equipoise is a strong progressive tax on consumption, on net cash flow, on income minus savings—with then no distinction between whether the income comes from wages or dividends or capital gains: if the income is saved, it escapes tax, and if it is spent on consumption goods and services it is all taxed at the same rate.


Other takes:

The proper tax rate on capital income is zero: Scott Sumner wrote on Feb 24th 2012, 13:58 GMT: ONE of the most basic principles in economics is that the taxation of capital income is inefficient. Taxes on interest, dividends, and capital gains represent a sort of “double taxation”, of wage income. For some reason many people have difficulty grasping this concept, and one often sees even Nobel Prize-winning economists talking about “income inequality” using data that includes both wage and capital income. This makes about as much sense as adding up blueberries and watermelons and calling it the “number of units of fruit”...

Make corporate tax rates as low as possible given arbitrage constraints: Hal Varian wrote on Feb 24th 2012, 14:04 GMT: I FAVOUR a consumption tax. Though this seems radical to some, it turns out that most Americans already face a consumption tax due to the many tax-deferred savings plans available. Such plans allow you to defer taxes on money saved in IRAs, 401(k)s, Keough plans and the like until the money is withdrawn and spent...

The benefits of tax reform to deficit reduction are overstated: Tom Gallagher wrote on Feb 27th 2012, 14:33 GMT: I'D LIKE to see the tax system move in the direction of a progressive consumption tax. I don’t have a detailed plan in mind, and I recognise the many difficulties in devising such a plan. This would require lighter taxes on capital income and higher rates on the remaining tax base, all in the context of unsustainable future deficits. Thus, this approach flies against prevailing political winds. But if I could I’d take the answer in a different direction. In many ways it’s unfortunate that tax reform is rising to be a first-tier issue. By the time tax reform ripens politically, possibly by 2014, the US may be far enough along in the deleveraging process that Washington should turn to addressing longer-term deficits, and I worry that tax reform could distract from or complicate that effort...

Taxing capital income provides automatic progressivity: David Li wrote on Feb 27th 2012, 15:16 GMT: I THINK, in today's world, there should be two objectives in redesigning taxes on capital.  The first should be to encourage corporate investment and therefore stimulate growth and employment.  And the second should be to enhance a sense of fairness among the general public.

Don't penalise future consumption relative to current consumption: Gilles Saint-Paul wrote on Feb 28th 2012, 16:52 GMT: THE economics of capital taxation are poorly understood by the general public, because they are in fact subtle. A common tendency is to advocate capital taxation on the grounds of some distate for capital, perhaps because capitalists are supposedly rich (and therefore disliked), or because they do not derive their income from their labour, which means they do not suffer for it, which is supposedly immoral. In fact, capitalists are not necessarily rich, they may for example be pensioners who have invested their savings in corporate bonds or equity in order to provide for their old age. If one wants to tax the rich, say for redistributive purposes, so be it, but then one should tax wealth or income irrespective of their source...

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