Standard Economics Says Capital Income Taxes Should Be Zero

April 4, 2013

We just raised the federal tax rate on capital gains and dividends from 15 percent to 23.8 percent, but most economists say these tax rates should be zero. Same goes for the corporate income tax.

Garett Jones explains, via the theoretical work of Christophe Chamley and Kenneth Judd:

First, let me sum up a key implication of Chamley-Judd:

Under standard, pretty flexible assumptions, it's impossible to tax capitalists, give the money to workers, and raise the total long-run income of workers.

Not, hard, not inefficient, not socially wasteful, not immoral: Impossible.

If you tax capital income and hand all of the tax revenue to workers, then in the long run (or the "steady state") you'll wind up with a smaller capital stock. And since workers use the capital stock to earn their wages, the capital tax pushes down their wages.

So far so obvious, standard supply-side stuff. At this point, you're probably guessing that sometimes the taxes you hand to workers are more than the fall in wages, sometimes it's less…it all depends on the assumptions, depends on the tax rate, depends on this or that. But the magic of Chamley-Judd is that they proved that "fall in wages > rise in transfer" is a pretty stable result…hence the need for "exotic" counterarguments.

Rational workers would rather have the extra machines to work with rather than a transfer from a tax on capital, thank you very much.

Follow William McBride on Twitter @EconoWill

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