Capital Income Taxation, Corporate
Taxation, Wealth Transfer Taxes and
Consumption Tax Reforms
Alan Auerbach
Becker Friedman Institute
September 27, 2013
Outline
• The Choice between Income and Consumption
Taxes
• Corporate Taxation
• Wealth Transfer Taxes
Income vs. Consumption Taxes
• Tax Wedges, Timing, and the Components of
Capital Income
• Equity, Efficiency and the New Dynamic
Public Finance
• Tax Salience, Inertia, Self-Control and
Targeted Saving
Tax Wedges, Timing, and the
Components of Capital Income
• Atkinson-Stiglitz (1976) and Chamley (1986)/
Judd (1985): two different rationales for
avoiding capital income taxes
– Not helpful vs. very distortionary
• But many additional, subtle points to consider,
regarding timing and what capital income is
Timing
• Dynamic inconsistency
– How much of an issue, in practice (TRA86
example)
• Labor income taxes vs. consumption taxes
– Differ “only” in transition but can represent the
difference between efficiency gains and efficiency
losses (Auerbach, Kotlikoff, Skinner 1983)
– Intertemporal elasticity of substitution less crucial
a parameter than in simple models
Components of Capital Income
• Safe return to capital vs. other components
– Quasi-rents to old capital
– Rents
– Disguised labor income
– Compensation for risk
• Consumption tax (EET) hits these, labor
income tax (TEE) does not
– Third alternative emphasized in Mirrlees Review:
TtE; makes clear role of safe return
Components of Capital Income
• How much of a difference does a tax on the
safe return to capital make?
– May be other reasons for taxing it, for example to
substitute for age-based variations in tax schedules
• For other components, different factors matter
– Flexibility of converting labor to capital income
– Efficiency of risk-pooling in private markets
– Mobility of rents
New Dynamic Public Finance
• Another reason to tax capital income: to relax
self-selection constraints in dynamic optimal
income tax setting
• Implications for capital income tax rates not
clear, since results relate to tax wedge
– Can be consistent with zero average tax rates
– Relates to “the” return to capital, not other
components of reported capital income
Tax Salience, Inertia, Self-Control and
Targeted Saving
• Saving is an area of focus in behavioral
economics
– Requires long-term planning and delayed
gratification
– Trade-offs may be difficult to understand
– Limited opportunity for learning
Issues and Implications
• With self-control problems, may want to
subsidize saving; but may not
– Offsetting aversion to saving vs. facilitating
meltdowns
• With excessive discounting, timing of tax
payments may matter – another distinction
between TEE and EET
Issues and Implications
• Employers and organized activity may be
critical
– Saving could actually be discouraged by more
general favorable tax treatment
• Are targeted saving schemes a good idea?
– Tax arbitrage vs. mental accounts; conflicting
evidence
Summary, So Far
• Capital income is different from labor income
• Tax rate on the normal return to capital is a
small part of the issue of how to tax capital
income
• Conclusions depend critically on how saving
decisions are made
Corporate Taxation
• A lot since Harberger!
– Developments in theory and evidence
– Also, a changing economic environment
Theory and Evidence
• As before, components of capital income
matter
• Sources of finance
– Debt vs. equity finance
– Retained earnings vs. new shares
• Dividend tax capitalization and the vanishing Harberger
triangle
– A marginal tax on new equity rather than on all
corporate capital?
Theory and Evidence
• As before, components of capital income
matter
• New vs. old capital
– With investment incentives, the same distinction as
TEE vs. EET
Theory and Evidence
• Consistent evidence of responsiveness to
taxation, but implications for tax policy not
always clear
• Strong cross-section responsiveness to
investment incentives
– Less evidence on aggregate responsiveness
– Relevance of liquidity constraints not clear
– Timing of policy interventions very predictable
Theory and Evidence
• Consistent evidence of responsiveness to
taxation, but implications for tax policy not
always clear
• Dividend policy responds to taxation
– Could be a timing response
– Evidence of agency effects
Theory and Evidence
• Consistent evidence of responsiveness to
taxation, but implications for tax policy not
always clear
• Borrowing responds to tax advantage
– But, again, may be limited by agency
considerations
Tax Policy and Agency Problems
• Dividend tax may exacerbate agency problem
– Encouraging managers to overinvest
– But, if so, why not raise the corporate tax?
• Managers may borrow to little for shareholder
wealth maximization
– But this may help offset the underlying tax
distortion between debt and equity
Changing Economic Environment
• The fall of the corporation
– Only half of business income now in traditional
corporate form
• The rise of the multinational corporation
– Most corporate assets now in multinationals
• Implications for corporate tax incidence,
distortions and design
– Additional margins of response to consider
Taxing Multinational Corporations
• With cross-border capital mobility, another
argument against capital income taxation
– Some evidence of shifts to labor, but econometric
challenges in using cross-country data
• Capital is not all that moves
– Financial and accounting adjustments to take
advantage of tax differentials
– Another cause for thinking about different
components of capital income
Taxing Multinational Corporations
• Hard to know what optimal tax system is, with
so many margins of responsiveness
• Another complication: tax competition
– How will other countries react (or cooperate)?
Taxing Multinational Corporations
• Typically, think about combinations of tax on
three components of income
– Domestic earnings of domestic corporations
– Domestic earnings of foreign corporations
– Foreign earnings of domestic corporations
– Existing systems choose 2 of 3, based on source or
residence, but obvious problems with both
• Relative immobility of consumers represents
an added argument for consumption-based
taxation
Wealth Transfer Taxes
• In some respects, equivalent to capital income
taxation; but important differences:
– Difficulties in administering taxes on wealth
transfers
– Uncertain lifetimes – annuity effect
– Different individuals involved
– Role in intergenerational persistence of inequality
Administering Wealth Transfer Taxes
• Infrequent taxation facilitates tax planning
• Should integrate with inter vivos transfers,
which may be hard to observe
• Clear evidence of responsiveness to estate tax
rates, but also that tax planning falls short of
rational optimization
Optimal Wealth Transfer Taxes
• Is the optimal tax a subsidy?
– How to take account of different generations in
measuring social welfare
– Can be progressive without being positive (FarhiWerning, 2010)
– May want to tax, for the same logic as in NDPF
(Kopcuzk, 2013)
Optimal Wealth Transfer Taxes
• Bequest motive matters
– Accidental bequests vs. warm-glow vs. altruistic
• Correlation of ability matters
– Can generate large optimal top tax rates (PikettySaez, 2013)
– Also an argument for taxing inheritances vs.
bequests
Optimal Wealth Transfer Taxes
• As yet, a lack of integration of theory,
evidence on responsiveness and issues of
administration
Conclusions
• Capital income is different than labor income,
so no obvious reason to think of income
taxation as a logical objective
• Capital income has different components, and
should think about how to tax these
components differently
• The intertemporal consumption decision is one
of many that are relevant to optimal tax rate
Conclusions
• Administration and enforcement need to be
integrated in tax design, particularly in
considering taxes on multinational
corporations and wealth transfers
• Decision-making and agency considerations
relevant, in some cases central
• Notions of optimality are also more difficult
once other generations and the responses of
other countries come into play