Capital income taxes with heterogeneous discount rates

  • Johannes Spinnewijn Johannes Spinnewijn
  • Peter Diamond Peter Diamond

With heterogeneity in both skills and preferences for the future, the Atkinson-Stiglitz result that savings should not be taxed with optimal taxation of earnings does not hold. Empirical evidence shows that on average people with higher skills save at higher rates. Saez (2002) suggests that with such positive correlation taxing savingscan increase welfare. This paper analyzes this issue in a model with less than perfect correlation between ability and preference for the future. To have multiple types at the same earnings level, the number of types of jobs in the economy is restricted. Key to the analysis is that types who value future consumption less are more tempted toswitch to a lower earning job. We show that introducing both a small savings tax on the high earners and a small savings subsidy on the low earners increase welfare, regardless of the correlation between ability and preferences for the future. However, a uniformsavings tax, as in the Nordic dual income tax, increases welfare only if that correlation is su¢ ciently high. There are also some results on optimal taxes that parallel the results on introducing small taxes.

Netspar, Network for Studies on Pensions, Aging and Retirement, is a thinktank and knowledge network. Netspar is dedicated to promoting a wider understanding of the economic and social implications of pensions, aging and retirement in the Netherlands and Europe.

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