Rethinking capital and wealth taxation

Abstract

This paper reviews recent developments in the theory and practice of optimal capital taxation. We emphasize three main rationales for capital taxation. First, the frontier between capital and labour income flows is often fuzzy, thereby lending support to a broad-based, comprehensive income tax. Next, the very notions of income and consumption flows are difficult to define and measure for top wealth holders where capital gains due to asset price effects dwarf ordinary income and consumption flows. Therefore the proper way to tax billionaires is a progressive wealth tax. Finally, as individuals cannot choose their parents, there are strong meritocratic reasons why we should tax inherited wealth more than earned income or self-made wealth for which individuals can be held responsible, at least in part. This implies that the ideal fiscal system should also include a progressive inheritance tax, in addition to progressive income and wealth taxes. We then confront our prescriptions with historical experience. Although there are significant differences, we argue that observed fiscal systems in modern democracies bear important similarities with this ideal triptych.