DP6366 Why Are Capital Income Taxes So High?

Author(s): Martin Flodén

Publication Date: June 2007

Keyword(s): inequality , optimal taxation , redistribution

JEL(s): E60 , H21

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP6366.asp.asp

The Ramsey optimal taxation theory implies that the tax rate on capital income should be zero in the long run. This result holds even if the social planner only cares about workers that do not hold assets, or if the planner only cares about any other group in the economy. This paper demonstrates that although all households agree that capital income taxation should be eliminated in the long run, they do not agree on how to eliminate these taxes. Wealthy households would prefer a reform that is funded by higher taxes on labour income while households with little wealth would prefer a reform that is funded mostly by high taxes on initial wealth. Pareto improving reforms typically exist, but the welfare gains of such reforms are modest.