A wealth tax spreads money and boosts consumer spending – reduces consumption inequality

Incorporating such heterogeneity shows capital income taxes and wealth taxes have quite different implications for efficiency. Adapting an example from the paper, consider two individuals, Alan and Betty, who each have $1,000 in wealth. Alan keeps his wealth as cash tucked away under his mattress, while Betty actively invests her wealth in productive investments. Many models assume that Alan and Betty get the same returns on their wealth. The authors, however, point out that if Alan earns a return of zero percent and Betty earns a return of 20 percent, a capital income tax falls entirely on Betty because she has a positive capital income of $200. Alan has a capital income of $0 and thus no capital income tax liability. Under a wealth tax, Alan and Betty—or any pair of individuals owning the same amount of wealth—pay equal taxes, regardless of how much income their wealth generates. Switching to a wealth tax rewards productive investments and broadens the tax base from just Betty’s capital income to both individuals’ wealth. This leads to a better allocation of capital and higher output than under capital income taxation. The authors find that the optimal wealth tax rate in their model economy is about 3 percent. The revenues from wealth taxes allow the government to reduce the tax on labor income—from 22.5 percent to 14.5 percent. Adding an exemption level to the optimal wealth tax changes the results only marginally: The optimal level below which one would be exempt from the wealth tax is fairly low—about a quarter of average labor income. And the tax rates on both wealth and labor income rise only slightly. In contrast, the optimal capital income tax rate is negative and large, about 35 percent, meaning that the tax system subsidizes capital income. In the authors’ model, an optimal wealth-tax economy delivers greater and more broad-based economic well-being than the optimal capital income-tax economy due to a large rise in the level of consumption driven by lower labor income taxes and a decline in consumption inequality. The distribution of consumption is more equal under a wealth tax because the rise in consumption is proportionally larger for lower-income people since wage income accounts for a higher share of their total disposable resources. In contrast, a capital income tax requires higher taxes on labor income—since it acts as a subsidy to capital income—thereby resulting in only a small rise in after-tax wages. In sum, the authors conclude that a wealth tax is preferable to a capital income tax because it has the potential to boost growth while also reducing consumption inequality.