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Optimal Taxation with Endogenous Return to Capital

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Abstract

This paper characterizes the optimal income and wealth tax schedules when rates of return are endogenous. Individuals exert investment effort in order to increase the return on their investments. Agents are heterogeneous along two dimensions: their investment ability and their labour market productivity. I show that when individuals can exert investment effort, the Atkinson-Stiglitz theorem that capital income should not be taxed does not hold. When the government observes wealth and capital income, it is optimal to tax capital income and subsidize wealth. When wealth is not observed, it is optimal to tax capital Income. The marginal tax rates on labour and capital income should not be equal, but they should be positively related to each other. The results extend to a model where individuals can hire investment advisors to increase the rate of return and also to a model with heterogeneous inheritance, in which case both capital Income and wealth should be taxed.

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  • Kristjánsson, Arnaldur Sölvi, 2016. "Optimal Taxation with Endogenous Return to Capital," Memorandum 06/2016, Oslo University, Department of Economics.
    • Handle: RePEc:hhs:osloec:2016_006
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    References listed on IDEAS

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    Cited by:

    1. Jacquet, Laurence & Lehmann, Etienne, 2021. "How to Tax Different Incomes?," IZA Discussion Papers 14739, Institute of Labor Economics (IZA).
    2. Bastani, Spencer & Waldenström, Daniel, 2018. "How Should Capital Be Taxed? Theory and Evidence from Sweden," IZA Discussion Papers 11475, Institute of Labor Economics (IZA).
    3. Eddy Zanoutene, 2023. "Scale‐dependent and risky returns to savings: Consequences for optimal capital taxation," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 25(3), pages 532-569, June.
    4. Spencer Bastani & Daniel Waldenström, 2020. "How Should Capital Be Taxed?," Journal of Economic Surveys, Wiley Blackwell, vol. 34(4), pages 812-846, September.
    5. Spencer Bastani & Daniel Waldenström, 2018. "How should capital be taxed? The Swedish experience," World Inequality Lab Working Papers hal-02878153, HAL.

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    More about this item

    Keywords

    Optimal taxation; capital taxation; endogenous return to capital;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies

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