Tackling the regressivity of the Italian tax system: An optimal taxation framework with heterogeneous returns to capital

In this paper, we exploit the new data available from the European Central Bank's Distributional Wealth Accounts (DWA) to reconstruct the distribution of capital income in Italy by accounting for heterogeneous returns to capital. With respect to previous estimates, we find that capital income is more concentrated along the income distribution and the Italian tax system is more regressive with lower tax rates hinging on the top 7%. We show that such rates are remarkably lower than those suggested by an optimal taxation approach and we provide estimates for revenues and inequality reductions that could be attained by applying (higher) optimal rates either to capital income or wealth while controlling for various degrees of behavioral responses. These results provide a direction for revenue-increasing and inequality-reducing tax reforms in Italy.