When is a wealth tax preferable to a capital income tax? When is the opposite true? More generally, can capital taxation be structured to improve productivity, incentivize innovation, and ultimately increase welfare? We study these questions theoretically in an infinite-horizon model with entrepreneurs and workers, in which entrepreneurial firms differ in their productivity and are subject to collateral constraints. The stationary equilibrium features heterogeneous returns and misallocation of capital. We show that increasing the wealth tax increases aggregate productivity. The gains result from the “use-it-or-lose-it” effect of wealth taxes when returns are heterogeneous, which causes a reallocation of capital from entrepreneurs with low productivity to those with high productivity. Furthermore, if the capital income tax is adjusted to balance the government's budget, aggregate capital, output, and wages also increase. We then study the welfare maximizing combination of wealth and capital income taxes and show that the optimal mix shifts towards a higher wealth tax and a lower capital income tax as the capital intensity of production increases. For a range of plausible parameter values, the optimal wealth tax is positive, whereas the capital income tax can be positive or negative (a subsidy). We then endogenize the entrepreneurial productivity distribution by introducing either ex ante innovation or entrepreneurial effort in production and show that this strengthens our results: by allowing entrepreneurs to keep more of the upside relative to a capital income tax, a wealth tax incentivizes more innovation and entrepreneurial effort, leading to larger increases in productivity, output, and welfare.
Authors
Fatih Guvenen, Gueorgui Kambourov, Burhan Kuruscu, Sergio Ocampo-Diaz
- Acknowledgements & Disclosure
- First draft: March 2021. For helpful comments, we thank participants at various conferences and seminars. We also thank Richard Blundell, Pavel Brendler, Christian Hellwig, Roozbeh Hosseini, Chad Jones, Paul Klein, Camille Landais, Francesca Parodi, Tom Phelan, Andreas Schaab, Florian Scheuer, Kjetil Storesletten, and Ludwig Straub for valuable comments. This research was funded in part by the project TaxFair, financed by the Research Council of Norway, Number 315765. Kambourov and Kuruscu thank the Social Sciences and Humanities Research Council of Canada. Ocampo also thanks the Jarislowsky Chair in Central Banking for financial support. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
- DOI
- https://doi.org/10.3386/w32585
- Published in
- United States of America
Table of Contents
- Introduction 3
- Model 10
- Model Description 10
- Entrepreneur's Problem 11
- Recursive Stationary Competitive Equilibrium 13
- Characterization of Stationary Equilibrium 16
- Steady State Levels of K and Z 16
- Existence and Uniqueness of Stationary Equilibrium 19
- Stationary Wealth Distribution 22
- Effects of Wealth Taxation 23
- Effects on Aggregate Productivity and Returns 23
- Effects on Aggregate Variables 25
- Effects on Individual Welfare 28
- Optimal Taxation 29
- Wealth Taxation with Innovation 33
- Stationary Equilibrium with Innovation 34
- Effect of Wealth Taxes in the Stationary Equilibrium 36
- Optimal Taxes with Innovation 37
- Entrepreneurial Effort 40
- Conclusions 43
- Further Equations for the Benchmark Model 51
- Entrepreneur's Problem 51
- Stationary Recursive Competitive Equilibrium 52
- Stationary Equilibrium without Endogenous Innovation 52
- Stationary Recursive Competitive Equilibrium with Innovation 53
- Proofs: Benchmark Model 54
- Innovation Effort 64
- Entrepreneurial Effort 71
- Entrepreneurial Problem with Effort in Production 71
- Equilibrium and Aggregation 73
- Optimal Taxes 78
- Alternative Modeling: Fluctuating Entrepreneurial Productivity 79
- Model 79
- Details: Entrepreneurial Problem 80
- Stationary Recursive Competitive Equilibrium 81
- Optimal Taxes 85
- Additional Figures 91
- Distribution of Wealth 94
