Tax On Capital & Savings Flashcards
(31 cards)
Capital accumulation is correlated strongly with what
Growth
Which is more mobile internationally
Capital is more mobile internationally than labour
Capital is more mobile internationally than labour as we have
Residence vs source base capital taxation
b) which is capital taxation mostly
Residence: tax based on residence of owner of capital (they may reside in a diff country to where the capital is)
Source: tax based on where the physical capital actually is
b) Most are residence based on where owner lives
Thus residence based tax means incidence falls on the owner: how can they avoid tax? (2)
Tax evasion (offshore tax havens)
Change residence to a place where residence based tax is low/zero
Which taxes are source based
B) who has incidence?
Real estate property tax (tax on where physical capital is)
B) Labour! Since capital is mobile i.e can leave country, hurts wages of domestic workers (since less productive with less productive capital)
Wealth equation (Wt) pg7
Differences in wealth and capital income due to (4)
Wt = Wt-1 + rtWt-1 + Et + It - Ct
Wt at age t
Et is labour income earnings
rt is ARR on investments
It is net inheritances (gifts and bequest received - gifts given
b)
Age (older have more wealth?)
Past earnings and past saving behaviour
Net inheritances It
Rates of return rt (some make more successful investments)
we know capital income inequality more concentrated and higher wealth inequality.
In US 2012 top 1% wealthiest families contribute to how much of total wealth
40% total wealth
2 types of wealth
Life-cycle wealth: is wealth from savings (responsible for this)
Inherited wealth (not responsible for this)
Life cycle model:
Individual lives 2 periods, works l, earns wl, consumes c₁ and c₂
What is savings expression (s) , if no taxes
S = wl - c₁,c₂ = (1+r)s
savings = income after deducting consumption
What is utility function
U = u(c1,l) + δv(c2)
V represents utility from consumption in period 2, which is discounted
Maximimses utility expression
max u (wl - c₂/1+r, l) + δv(c₂)
wl is income/consumption today
c2/1+r is present value of future consumption
which shows utility is a function of consumption (wl - c₂/1+r) , and labour
So maximise utility subject to the intertemporal budget constraint
What is the BC
c1 + c2/1+r <=wl
Present value of consumption has to equal labour income!
Then workers decide how much to work and save.
Where do they save up to?
Saves up until where their MU is equal across time
(MU₁ of c1= present value of MU of c2)
du/dc1 = δ(1+r)du/dc2
If we introduce a consumption tax (tc)
what happens to the intertemporal budget constraint
just add 1+tc to the equation
(1+tc)[c1 + c2/1+r] <=wl
What if we tax labour income (tl)
what happens to intertemporal budget constraint
Just add (1-tl) to RHS.
c1 + c2/1+r <= (1-tl)wl
When would consumption tax and labour income tax be equal?
b) What do they both have in simiilar
if
1+tc = 1/(1-tl)
b) both taxes distort only labour supply not savings!
So tc and tl only affect labour supply not savings.
Now a capital income tax (tk) : what happens to the intertemporal BC?
b) What does a capital income tax distort
Add (1-tk) to 1+r part on LHS
c1 + c2/[1+r(1-tk)] <=wl
Capital income tax only distorts savings (not labour supply)
So tc and tl only affect labour supply not savings. tk only affects savings not labour supply
What about a comprehensive income tax t on both labour and capital income
b) what is distorted
c1 + c2/[1+r(1-t)] <= (1-t)wl
b) both labour supply and savings (a double tax! taxes both earnings and savings)
Simpler model to show how capital tax distorts savings. For simplicity let c1 = w - s (earnings is fixed in C1, just w not WL!)
So
IBC: c1 + c2/[1+r(1-tk)] <=w
Suppose tk increase: what happens (sub+inc effect and net effect)
Substitution effect: price of 𝑐2 ↑ ⇒ 𝑐2 ↓ and substitute for consumption in 𝑐1 ↑ so less savings shown by 𝑠 = 𝑤 − 𝑐1
Income effect: consumer is poorer ⇒ both 𝑐1 and 𝑐2 ↓ ⇒ savings 𝑠 increase.
Result: Net effect ambigious
How can we express this capital tax diagramatically with its sub and income effects
Pg 16 shows initial status, pg 17 shows the capital tax introduction
Y axis c2
X axis c1
Capital tax affects savings! So less possible consumption for C2. So flatter BC slope.
Draw new lower IC on the new BC
Substitution effect is the fall in savings (so gap between c*1 and w gets smaller)
Income effect is overall less income so reduced consumption, so savings increase.
In this diagram example pg 20 we can see income effect outweighs substitution effect since overall consumption has fallen and savings has increased.
Current US tax system: what is taxed
B) what do some conservatives advocate for?
Income tax which taxes both earnings and capital (targets earnings and savings, just like the comprehensive tax example)
B) some want shift to consumption tax
Cons of going from this labour tax to consumption tax
It generates double taxation of transitional generation (those who paid labour tax when working, now also need to pay consumption tax when old - unfair)
Are consumption taxes progressive?
No, tend to be flat
Opposed to income tax which are generally progressive (so consumption taxes maybe not as good for equity)
That was life cycle: wealth from savings
Now look at inherited wealth
Atkinson-Stiglitz theorem: what did he view the optimal tax on capital (tk)
Zero, labour income tax T(wl) is sufficient
I.e savings should not be taxed
