The plethora of discount
rates and taxes obscures the basic point in Feldstein’s argument against
capital taxation. Here is a bare-bones version.
There are three
goods, labor, apples and oranges. Assume that the government taxes
oranges at a higher rate than apples. A tax on oranges is also a tax
on labor since you need labor to buy oranges and if the price of
oranges is high the value of your labor is low.
Now let’s show
that a reduction in the orange tax matched by an increase in the labor
tax to keep total tax revenues constant can make everyone better
off. The simplest case is to assume a tax on oranges so high
that no one buys any oranges. Orange tax revenue is therefore zero.
Now we get rid of the tax on oranges and add an equal-revenue tax on labor
(zero). So long as the consumer cares at all about oranges he now buys
more oranges and is better off (because he now consumes a variety of
fruit and has an increased incentive to work). The consumer will still be better off even if we replace the zero-revenue orange tax with a
small labor tax which increases government revenues. The zero-revenue assumption makes the argument obvious but is not at all necessary for the results.
The basic point is that the tax on oranges distorts the labor-leisure choice and the apples-oranges choice. A tax on labor distorts only the labor-leisure choice and so is preferred.
For Feldstein’s argument rename oranges as savings, apples as present consumption and labor as income. To see a counter-argument introduce more people into the model and rename oranges as yachts.