Does capital taxation hurt an economy?

Following my Econoblog debate with Max Sawicky, Kevin Drum writes:

Basically, I’m on Max’s side: I think taxation of capital should be at roughly the same level as taxation of labor income. However, I believe this mostly for reasons of social justice, and it would certainly be handy to have some rigorous economic evidence to back up my noneconomic instincts on this matter. Something juicy and simple for winning lunchtime debates with conservative friends would be best. Unfortunately, Max punts, saying only, "As you know, empirical research seldom settles arguments."

Let me repeat the chosen comparison: capital taxes vs. gasoline taxes and no subsidies for housing.  That is a no-brainer.  But still you might be interested in the question of capital taxes vs. labor taxes.  Here are some points:

1. Supply-siders writing on capital taxation often make exaggerated claims.  Even if you like their conclusions, beware. 

2. Taxing dividends, corporate income, returns to savings, and capital gains all involve separate albeit related issues.  I am willing to consider zero for the lot.  Of that list, the corporate income tax is probably the biggest mess.  The capital gains tax is the least harmful.  The tax on dividends is the least well understood (in perfect markets theory, the level of dividends should not matter at all).  By the way, if you are worried about noise traders, a transactions tax is a better way to address this problem than a capital gains tax.

3. The U.S. currently lacks exorbitantly high levels of capital taxation.  Joel Slemrod estimates a rate of about fourteen percent, albeit with many complications and qualifications.  N.B.: We lower the rate of tax on capital by engaging in crazy-quilt and distortionary adjustments.  Nonetheless it is incorrect to argue "we have high rates of capital taxation and are doing fine, better than Europe."  Do not confuse real and nominal tax rates.

Take the capital gains tax.  Once you consider bequests and options on loss offsets, the effective rate of tax is arguably no more than five percent.  But it is still set up in a screwy way.  Bruce Bartlett points me to this short piece on real tax burdens on capital.

4. Peter Lindert has good arguments that favorable capital taxation has helped European economies finance their welfare states.

5. Larry Summers did the best empirical work on how abolishing capital income taxation would boost living standards. 

6. Encouraging savings will have a big payoff.  If you tax capital at zero, in the long run you will have much more of it.  This holds in most plausible views of the world.  Max’s examples aside, the supply curve for savings does not generally slope downwards; nor need you write me about various strange counterexamples from Ramsey models.  Sooner or later, more capital will kick in to mean a much higher standard of living.

7. Bruce Bartlett points me to this excellent CBO study.  It shows how much capital is taxed unevenly; one virtue of a zero rate is to eliminate many of those distortions in a simple way.

8. Remember those arguments about how more money doesn’t make you happier?  And we are all in a rat race where we work too hard to win a negative-sum relative status game?  I’ve never bought into them, but it’s funny how they suddenly stop coming from the left once the topic is capital vs. labor taxation.

9. The same excellent Slemrod paper (and he is no right-wing supply-side exaggerator) also suggests that the revenue lost from a zero rate on capital would be small.  N.B.: The references to this paper are the place to start your reading on this whole topic.

10. Kevin Drum’s belief in social justice should not necessarily lead him to look for arguments for taxing capital.  Even if we accept his normative views, there is the all-important question of incidence.  Taxing capital can hurt labor.  If you are truly keen to tax capital, this is a sign of a high time preference rate, not concern for the poor.

11. Some forms of human capital also should receive favorable tax treatment.  Vouchers for primary education and state universities are two examples.  I am also happy — in part for equity reasons — to subsidize human capital acquisition through an Earned Income Tax Credit.

12. What is really the difference between capital and labor?  Is it simply measured elasticities?  The size of each potential tax base?  The greater "future orientation" of capital and the possibility for compound returns?  All of the above?  How much does your answer depend on whether you view capital as a "fund" or as a "collection of capital goods"?

The bottom line: It all depends on the margin.  If your levels of government spending allow you to keep labor rates of taxation below 40 percent, I don’t see comparable gains from lowering tax rates on labor.  If you have equity concerns, express them through other policy instruments.  But if your marginal tax on labor is 65 percent and your tax rate on capital is 15 percent, cut the tax on labor first.

I know it hurts, but all of you non-right-wingers out there should consider a zero rate of taxation on capital.  Comments are open.


As a non-right winger my gut instinct is against a zero tax on capital. However, several of the arguments here are presuasive. Certainly increasing the national savings rate would be a good thing.

Yet from a purely practical standpoint we know that under the Bush Admin. tax cuts are not offset by spending cuts. Our current fiscal policy seems to be in enough of a mess that I'm wary of any further tax cuts until the deficit can be reduced. Re:#9, I've admittedly not read the Slemrod paper. Maybe the lost revenues would be less than I'm thinking? I'm skeptical of anything that sounds like a Laffer Curve.

Would taxing capital at zero(or less than current levels) help labor, as #10 seems to imply? The non-right wing skeptic in me wonders if excess capital would simply fuel asset bubbles like housing, rather than being invested in anything that improves the situation for labor.

Excess capital?

Let's face it though, in the year 2075 people will asking "How am I supposed to be able to support their family on $150,000.00 per year?" I say let's screw the ungrateful jerks. High capitol taxes!

Seriously, why would anyone be against high levels of growth? Don't future people count when we're being altruistic as well?

What is the relative impact of taxing capitol vs. not on wealth inequality? Growth is good if it is stable. I worry that large weath inequality coupled with low mobility may lead to social instability. That is not based on anything resembling hard data and sound reasoning, just a general fear of the trend toward aristocracy and the ruling class losing touch with the working class.

Paul N is right. Volatility of the tax code is the great unspoken and undiscussed issue, the plaything for all the rent seekers in Washington and the tax accounting industry. And if you think getting a computer program to do your taxes will help, well, some of them have errors in them, although of course the code is so complicated and changing so much all the time, who would know anyway?


I see now that the discussion between you and Max has been somewhat confused and muddied. You initially said that you were for zero capital taxation. Now you present a more nuanced position. What Summers was critiquing, I believe, although I may need to go back and check on it, is that old bugaboo, the double taxation of dividends, something criticized on efficiency grounds for decades by all kinds of tax economists. Glenn Hubbard made some attack on that as he went out the door, if I remember correctly.

As I stated, I am for pretty radical tax simplification (and then leave it alone). I would be willing to go along with getting rid of the corporate income tax if dividends and realized capital gains were taxed as income in a similar manner to labor income. Given that it is retained earnings that is the major source for financing the growth-enhancing real capital investment, in contrast to the forms of savings that people engage when they buy stocks and bonds (and speculative real estate) that they call "investing," this makes some sense.

I'm still unclear why it is necessary to have an unbalanced playing field between capital and labor income. Again I propose a hypothetical. Imagine one person who earns $100 interest on a savings account or as a capital gain when he sells some stock. Imagine another person who earns $100 by working some extra hours during the holiday season. The assumption here seems to be that the first person is doing more to contribute to economic growth than the second person therefore should enjoy lower taxes (or no taxes at all).

Yet if this is true then why wouldn't a free market reward the first person properly? Why, if his actions are more productive, is he rewarded by the market with only $100? Why doesn't the market reward him $120 or $150?

Second what evidence is there that the gov't knows how much the reward should be? Certainly there must be a limit! If there isn't then not only should capital gains be taxed at 0% they should be taxed at a negative rate! Why reward the first person with 0% taxes? Why not subsidize him with -100% taxes if his contribution to the economy is so much larger? The question goes on from there, why not -200%, -300% and so on.

So clearly Tyler seems to be implying there is some 'optimal' level of reward for deriving your income from capital rather than labor. Try to push people beyond that and you'll generate a suboptimal position. Yet in almost every other area in economics the primary tool for finding the optimal level of anything is the market. Here, though, it is the government who appears to have to step in just a bit to nudge the rewards slightly more in favor of capital. Why does the market suffer an inherent flaw that causes it to always slightly under reward capital?

Sheesh. Never ask Tyler to clarify anything. You just end up with more snow.

Tyler lumps the CG tax with corporate income tax for no good reason. That makes no sense. I'm open to the suggestion that we should abolish tax on businesses (they are mostly using bermuda headquarters anyhow), but if you do that, why not make up for the lost earnings by raising the CG tax? If those businesses benefits by doing business in America, it's only fair that they cough up some profits to keep America up and running, one way or another. Tyler conceded that a CG tax would not be that harmful at all.

As for the "we need to encourage investments to grow our economy" angle, Tyler knows full well that the vast majority of capital investment in this country does not come from individuals, but corporations. Even taking the supply-side point of view that more capital investment = more growth, the CG tax, at least, is moot.

Talking about Europe, the point there is you've got a real inadvertant econ lab there. Some countries have very high CG tax, and others extremely low ones. There's no pattern as to how this affects the economy. I don't think the swedish or U.K. economy is hurting relative to France because their economy starves for capital. True, the U.K. has a savings rate that's scary-low. But that probably has to do with the whole bubble-fueled using-your-house-as-an-ATM craziness that's similar to what's happening in the states.

"Taxing dividends leads to severe distortions, since returns from equity capital are double-taxed while debt capital is treated favorably by most tax regimes. "

The double tax comes from the legal NON-fiction of the corporation being a distinctly different legal entity from the owner of the corporation. Point of order, any business can avoid the double taxation simply be remaining a partnership or sole owner/operator. The decision to opt for corporate status comes because the legal benefits of incorporates outweigh the costs.

much capital is taxed unevenly; one virtue of a zero rate is to eliminate many of those distortions in a simple way.

This also a "virtue" of a 100% rate.

the corporate income tax is probably the biggest mess

The corporate tax is a "mess" largely because corporations have lobbied successfully for all sorts of special tax privileges, and taking advantage of them is complicated. So now the complaint is that the whole tax should go away because it's too complicated?

What is really the difference between capital and labor?

Less than you are pretending. Isn't much labor income fairly described as return on capital, human and other?

And how can anyone talk about reducing capital taxes to zero without discussing the social consequences?

Nice catch!

I think Tyler is arguing until the tax on labor is above forty percent, the deleterious effect of raising the capital gains tax on the economy is higher than the deleterious effect of raising the income tax. But reasonable fellow that he is, he will concede that taxing labor at, say, 65%, might have an even more alarming effect on the economy than taxing capital gains at 15%

I'd like to see some real numbers.

The effective capital tax rate today is 15% if what was written above is true. The effective labor tax rate today I'm guessing is 40% including withholdings and everything else at all levels of government. I'd also guess that all the state sales taxes together make an effective consumption tax of 5%?

From a foggy memory I think labor income is twice as big nationally as capital income annually, so zeroing capital taxation can be replaced by increasing labor taxation 7.5% to 47.5%.

If there are no lasser effects, it is possible to zero labor taxes with capital taxation of 95%. Just hypothetical based on the relative sizes of the tax base.

The tax rates can be set equal if capital and labor are effectively taxed at about 31% each, which would mean to double the capital tax and decrease the labor tax by a quarter.

So with these numbers in hand:

Cowen is arguing that 0%/47.5% is preferable to either the current 15%/40% or 31%/31%.

At 0%/47.5% people who do not work for a living pay no taxes at all. That seems like a perverse incentive structure. It also seems unbearably unfair and difficult to maintain in a democracy. As a liberal, nothing would make me happier than if somehow the Republicans were to get this, because this would be a perfect invitation to rebuild the tax system from scratch with labor income, capital income and inheritance income all taxed at equal rates.

Decreasing the tax on labor by a quarter may well lead to more labor being supplied to the economy. Leaving one quarter of the labor tax bill in the hands of consumers who work for a living will result both in greater private consumption and some amount of greater private saving.

I'd take 31%/31% over 0%/47.5% any day. I do not think there is a clear argument that 0%/47.5% necessarily leads to faster growth rates than the alternatives.

Oh also about point 8 where liberals don't talk about money not making you happier. I'm not sure the major liberal blogs have ever even mentioned that study so it is not that interesting that they "stop" when discussing capital taxation. I'd like to see an example of a liberal who has stopped making an argument related to happiness when it is time to discuss the optimal level of capital taxation.

How embarrassing to leave a long post whose arguments are better made earlier in a thread.

Boonton at 11:24:06 made the definitive argument that 31%/31% is preferable to 15%/40%, 0%/47.5% or even -10%/52.5% (and I obviously hadn't thought of the third one).

Sebastian Holsclaw at 11:38 entirely missed the argument which is that if labor and capital are taxed equally, the market can decide which activities deserve to be rewarded more. Believers in market efficiency should find this argument decisive.

"If there is no market failure that causes the economy to consistently over-reward labor, than there is no argument for "fixing" that failure by taxing labor and not capital."

I think the argument would be that the abysmal savings rate is evidence that incentives to save are not correctly aligned.

I just sent this to Arnold Kling in response to his call for a 40% tax on all consumption, elimination of all entitlements, and a$7,000 stipend per person.
It is the observation of numbers like those in your "bleeding heart libertarianism" column that make me want to abolish Democracy. The superiority of such a system is SO BLOODY OBVIOUS. However, a few caveats are needed.
1) Count benefits paid by a business as spending. (or simply abolish the concept of a "business" in the absence of any tax need for such a concept.
2) Something has to be done to manage immigration, making immigration viable without drawing in a huge fraction of the world's poor. One obvious option is to make the deductible zero for everyone not born in the US and have free immigration.
3) Defining spending can be difficult. Are interest payments "spending"? People who own real property derive rents from them, is that spending? Charitable donations? Local taxes? Are you proposing eliminating federalism entirely? If not, local taxes should probably count as spending, spending on public goods associated with living in a particular locality.
4) Some taxes, such as taxes on congestion, CO2 emissions, and a variety goods which impose externalities, are arguably goods in and of themselves. Let's retain these taxes, and also some luxury taxes, as much luxury consumption creates status externalities.
5) Paying for msc governmental functions plus the cost of living is not feasible for $20,000/year. Let's make the taxes in category 4 high enough to raise the deductible somewhat (if possible from $7,000 to the official 1 person poverty level of $9,570?). Also, eliminate harmful gvmt functions like the drug war to raise some more money. If this isn't enough, raise the consumption tax to a clean 50%. This would still be cheap compared to paying for a near-future welfare state and compared to pre-Reagan marginal tax rates or European tax rates. Finally, allow local governments to redistribute as they wish, including supplementing stipends with "Henry George" style land taxes and implementing "welfare" functions if they think doing so is efficient.
6) Some people will rapidly go into debt and soon will owe their deductible as interest. Make bankruptcy as simple as possible and let the lender beware of bad credit risks.
7) This will eliminate a huge number of pernicious jobs, at least at first, driving the price of labor down, but it will also eliminate the incentive to work in many people. How can we estimate the net effect on the price of labor? If the cost of labor falls too far, will pressures to admit immigrants with no stipends lead to major externalities (a-la Europe)? Would a simple solution be "non-stipend holders are deported with the first felony conviction and executed with the second?"

Finally, the big one. How (and where) on Earth can we get something like this implemented?

On the plus side, eliminating food tariffs would drive the cost of food WAY down for many families, as would the decoupling of government services and funding from location, which would allow a massive rural migration.

"From a foggy memory I think labor income is twice as big nationally as capital income annually,"

Over the past century, tax rates on capital and labor income and the ratio of the two have all varied considerably. IIRC, this ratio of 2:1 for how national income is allocated between labor and capital has remained remarkably constant over the same period. This would seem to suggest that tax rates are something of a second-order effect. If that is true, I would vote in favor of simplicity and tax capital and labor at the same rate.

“Peter Lindert has good arguments that favorable capital taxation has helped European economies finance their welfare states.†

No he doesn’t.

As usual with Linderts it’s heavy on anecdote and light on facts. The European Welfare states simply do not have lower capital taxes. They higher or similar capital taxes as the US, but much higher labour taxes. But it’s not the ratio, it’s the level.

As a proxy in his data for property taxes he uses real estate tax, higher in Anglo-Saxon countries and lower in welfare states. But this is really the complete opposite argument! To the degree that real estate values reflect land rent (a significant part) real estate taxes go after an inelastic, whereas Lindert claims the US taxes elastic factors and the wise Scandinavians tax inelastic ones.

“The capital gains tax is the least harmful.†

Hmmm. I don’t know if he has some special theory in mind, but the New View suggests capital gains taxes matter more than dividend taxes, and the Old View that both are equally bad.

Panda, what you call "snow", those of us on planet Earth call "evidence." Perhaps the Panda's not quite so ready for battle?:)

And Panda, the idea that investing in bonds and the stock market is not productive because it's like "trading gold ingots" is really quite silly.

Bonds are essentially loans to corporations, who use those loans for capital equipment. Buying and selling of stocks funnels capital towards its most highly valued use. Making the capital stock more productive is just as, if not more, important to society as adding to the stock of existing capital.

I think Max and Panda are more ideologically blinded than Tyler, by the way. I think Tyler normally doesn't open comments because they're lower than the quality of his posts.

I think Craig is on to the mistake that a lot of people are making on these comments. A lot of people on the comments, including Booton and Panda, make the error of treating capital and labor as substitutes for household decisionmakers.

Boonton's example is quite instructive, in a negative way. Boonton says that a person can choose between working overtime for $100 or earning $100 on a bond. But Boonton is wrong. Working overtime for $100 does not in any way diminish my ability to invest money to earn $100 in interest-bearing bonds. Thus, treating the two as different from taxation does not cause a distortion. In fact, as Craig points out, since savings derives done from forgone consumption, a consumption tax also taxes savings. In addition, if we tax capital, we lower the amount that people make from labor, because capital raises wages by raising the marginal product of labor.

There is a more subtle point, however, that Tyler isn't addressing. It's true that linear capital taxation is very distortionary, because the linear capital tax gets more and more distortionary over time. In an infinite horizon model, the linear capital tax should be zero.

However, Tyler doesn't address the issue of non-linear capital taxation. As Berkeley economist Emanuel Saez discusses in this working paper - -
you can achieve a lot of redistribution without much welfare loss with non-linear capital taxation, like a zero percent tax up to some level, and then a giant tax thereafter.

So maybe we can reach a synthesis. Zero linear capital taxation (zero corporate and capital gains taxes), end the housing deduction, and bring back the inheritance tax, which could act as a non-linear capital tax. Or consider a zero capital gains tax up to some very large level, and then a big tax kicks in.

"...any business can avoid the double taxation simply be remaining a partnership or sole owner/operator"

This is another example how double taxation of dividends distorts the market, thank you, Boonton.

The labor supply is based on individual labor-leisure tradeoffs. The capital supply is based on individual present/future consumption tradeoffs.

If we follow Tyler's proposal and zero out capital taxes we push labor taxes to nearly 50%. That is the same thing as an economy-wide doubling of interest rates relative to labor earnings.

In an economy without any taxes at all, the market pays people to invest instead of consume during the present. The rate the market pays is the interest rate which tends towards the marginal return to capital. As an economy has access to more capital to fund the most profitable projects, the return of the unfunded project at the margin decreases and therefore the interest rate decreases.

Using government fiat to double interest rates economy-wide _certainly_ will drive the economy to invest in capital beyond the point where the marginal return to capital is equal to the marginal return to labor. It will _certainly_ lead to overinvestment in capital relative to the optimal labor/capital mix.

Given an economy with a neutral tax system where free individuals trade their leisure for wages and their present consumption for future consumption at the rates that prevail in the market, the rates that prevail in the market are the rates that set the marginal product of capital equal to the marginal product of labor. The natural rates are the rates that are best for the economy given the individual preferences.

Now there are ways to cause the capital stock to grow faster than people would naturally be chosen by the individuals of the economy. One way is to introduce slavery. Get everyone to work 18 hours a day until they drop dead at retirement age, pay them only subsistance and invest the rest in capital. This scenario is the fastest the capital stock can possibly grow in theory.

Another way is to cut wage income in half but leave capital income whole. The capital stock will grow faster that way because given the preferences in the economy, government is forcing the economy to vastly overinvest in capital and vastly underinvest in labor.

This is yet another case of false-libertarianism. A true libertarian does not use government to disrupt the labor/leisure or present/future consumption preferences of the individuals who make up an economy. But people who derive a larger proportion of their income from capital use libertarian-sounding arguments to convince the government to favor themselves at the expense of people who derive their income from labor.

Decreases of income on capital don't seem to have increased national savings recently.

I also think at times there is too much money for "capital" of certan types, the stock market boom amd currently real estate.

Often these involve no new actual production or a limited amount as with purchases of existing stocks whose higher price may help a company finance by selling more stock, but even here it's a percentage.

High prioces also seem to increase the severity of busts.

If the goal is savings and investment for the majority then we can simply say no capital gains tax on the first quarter millon or half million or whatever, this would allw us to trteatt stocks and primary residences equally rather than giving advantages to the later.

Corporate taxes may be a mess as now applied, but this doesn't mean a rational system can't in theory be created and applied.

The argument that because the current system has been gamed that the rationalizations behind it are invalid gives the gamers defacto rule.

And if extended hen people like Paris Hilton will find ways to pay no taxes which will further undermine the belief of those who wok that there is any social responsibility for them to pay.

"This is another example how double taxation of dividends distorts the market, thank you, Boonton."

Pavel, you ignore the fact that the corporation is a gov't created entity in the first place. Are corporations distinct individuals from their owners? If not then the concept of the corporation itself is a distortion created by the gov't (one that is mostly positive IMO).

"The labor supply elasticity derives from the labor-leisure tradeoff, while the capital supply elasticity derives from the present consumption-future consumption tradeoff. To the extent these elasticites differ, the optimal taxation rate of capital and labor differ. If the present-future consumption tradeoff is a lot more elastic than the labor-leisure tradeoff, then the optimal rate of capital taxation is lower than the optimal rate of labor taxation. And Tyler's saying it is."

A supply curve can exhibit different elasticities at different points along itself. The supply curve for labor may be rather elastic at this point where the high cost of supplying labor (thru high taxes) basically means the only people who supply labor are the people who have more or less no choice but to supply labor.

Additionally, curves will have different elasticities depending upon what time frame you're examining. Long run curves will naturally be more elastic than short run. Inside a market supply curves will exhibit different elasticities as well. The supply of McDonald's workers is probably more elastic than the supply of brain surgeons. Should income taxes for McDonald's work be lower than surgeons?

By your reasoning a world where neither labor nor capital is taxed would therefore be distortionary since you seem to be implying the elasticity of capital requires lower taxes than labor income...that would hold if the tax rate was 0% for both as much as if it was 30%.

Finally, on the issue of corporate organization and the appropriate price to pay for limited liability, nobody that I know of has ever made a convincing case that double taxation of corporations is the appropriate price to pay for limited liability. How does double taxation exactly reflect the marginal social cost of limited liability for each corporation?

I'm not sure how to make such a case but isn't it a fact that many businesses that could easily be organized around partnership or sole ownership model are nevertheless organized as corporations? Why would their owners choose this more expensive method if the legal benefit did not outweight the cost of double taxation?

I think a better idea would be the following: Move to the English rule of loser-pays, except when the defendant is an LLC. And remove double taxation.

I think you're thinking that the main benefit of limited liability is protection from spurious lawsuits. The main benefit is that you are not on the hook for your corporation's debts. If this wasn't the case then anyone who owned Enron stock would be liable for Enron's unpaid bills as well as lawsuits. In fact, even the act of owning stock would put someone's credit score at risk rather than being viewed as a positive asset!

On the narrow issue of whether or not a zero tax rate on capital goods would increase the growth rate of an economy's capital stock I think we can settle on an answer of yes.

Future consumption is bought on a market just like a lot of other goods and the price, the interest rate, is a market clearing price that is efficient in an efficient market.

The government can shock the demand for capital by setting the after tax value of returns from capital at twice the after tax value of returns from labor. But this is a result that the individuals in the economy could produce themselves if they wanted to just by having different present/future consumption preferences. For example if every individual in the economy assigned zero value to present consumption they would willingly produce the same outcome as the earlier slavery example - they would work 18 hours a day and live off of subsistence until they drop dead at retirement age.

So from a libertarian point of view the question of should government use tax policy to engineer the growth rate of the capital stock I think the answer is unarguably no.

Right now in the United States, capital has an after tax value 40% greater than labor ($85 vs $60). That is already a government-produced distortion in the market that necessarily leads to sub-optimal outcomes given the preferences of the individuals who make up the economy.

Tyler would increase the capital advantage to 100%, so that 1 dollar from capital has the same after tax value as 2 dollars from labor. At that point maybe he would advocate increasing the advantage to 160% by an outright subsidy or negative tax on capital, paid by labor taxes. Maybe he would keep going until people who work for a living put in 18 hour days and live off of subsistence until they drop dead at retirement age.

That is not libertarianism. That is capital income receivers as an interest group using their greater access to government power to extract rent from labor income receivers.

"Pavel, you ignore the fact that the corporation is ..."

No Boonton, I don't ignore it. I only claim that legal differences between particular types of companies are irrelevant from the economic point of view.

Is this issue settled or is there an argument for zero or reduced taxes on capital that advocates think has not been addressed?

"Bernard: OK, but where's the case for dividend taxation?"

The legal argument is that corporations being a distinct individual from their owners they pay independent taxes on their income. Economically I suppose I would argue that this is the premium for the additional legal privileges that come from the corporate form. I would be agreeable to simply abolishing corporate income taxes accross the board. Then there would be no double taxation argument. Dividends would simply be treated as personal income as would interest on bonds or anything else.

is there still somebody that think taxation of capital is a good thing?

But everyone who has been through intro to micro understands that production is maximized when the condition that the return from one extra dollar devoted to labor produces is the same as the return from one extra dollar devoted to capital.

By tilting the entire economy through the tax system, so that a dollar from labor is worth twice what a dollar from capital is worth a the economy will continue to overinvest in capital until a the marginal return to capital is *one half!* of the marginal return to labor.

Depending on how steep the capital to output curve is, we can be talking about a *vast* overinvestment. Meaning the economy would produce a lot more if money was taken away from capital and put into wages.

Rather than tilting the economy with by changing the basic value of a dollar from capital, it would be better just to give a direct subsidy, vouchers or stamps to the poor capital investors you are trying to protect.

Pure interest group politics with no possible economic justification. No different from corn subsidies.

Robb, you've articulated the problem with the supply of savings/capital. There's two main motives and they contradict each other. If you are seeking income then a higher return means more income the more you invest so rising rates mean you should put more in the bank. This we know from real life since banks that want more deposits will advertise higher returns on their savings vehicles than other banks.

On the other hand, if have a particular goal (such as $1M saved before you turn 65) then a higher rate of return makes it easier to reach that goal with less money. Since the two forces contradict each other there's no theoretical reason why one force is always stronger than the other. The effect of higher rates on the amount saved, cetris paribus, is not determinable.

"Strictly in terms of per-capita growth, all capital would be better to be invested. The fastest a capital stock can possibly grow is if there is no consumption at all. If only 1 percent of a nation's income was consumed, that nation's capital stock would grow faster if that consumption was reduced."

The problem with this is that in order for a capital good to be produced both supply and demand must be meet. Here's a simple example. Should Joe purchase a snow plow and make money plowing driveways this winter? In order for this investment for a capital good to work:

1. Joe must either have savings or get a loan from someone/something that has savings to buy the plow.

2. There has to be people who will choose consumption (buying plowing service rather than shoveling their own driveways) to make Joe's investment worthwhile.

In a world where everyone is refusing to consume and everyone is saving the investment will not happen because even if Joe can get the loan at 0% he cannot pay it back because he will have no customers. GDP does not grow because no plowing services are produced in the winter despite the fact that people are saving as much as they can.

Classical Keynes based economics would call this scenero a savings glut and would say that modern capitalistic economies were particularly vulnerable to it.

Aye but you see the point isn't that everyone will buy snow plows but make no money on that investment. The point is that no one would buy snow plows at all since there's two pieces to the equation. There's the ability to buy the capital good (which savings obviously helps you with) but there's also the motivation which is linked to consumption. If no one wants to consume what's the point of a capital good? By definition a capital good is something used to produce consumption goods (or other capital goods).

Comments for this post are closed