L11: Capital Income and Wealth Taxation - Introduction; Retirement Saving

Question 1

three different views of what capital income taxes should be

Answer 1

J.S. Mill
- shouldn’t tax capital income, but should only tax spending
- advocating a consumption tax since otherwise, it would be double taxation where you pay taxes on earned income but you would also be taxed on savings if you earn interest, etc.

PJ Proudhon
- property is theft, Marxian POV of 100% tax rate
- all value in the economy produced by labour and all earnings from capital are subjugation of labour so it’s unfair

Haig-Simons approach
- same rate as labour income
- Buffett rule where they shouldn’t face lower tax rates than their secretaries

Question 2

why is capital income and wealth taxation of particular interest?

Answer 2

capital income/wealth more unequally distributed
- large role in economic inequality and intergenerational transmission of inequality

associated with growth, increasing labour productivity and living standards

more challenging to measure and tax than labour income/consumption

economic distortions are a concern
- several economic decisions more sensitive to capital income taxation than labour income taxation
- decision to work and to get educated

Question 3

calculation of wealth in a given year

Answer 3

wealth in the previous year + rate of return on that wealth + inheritances + labour earnings - consumption

Question 4

differences in wealth among individuals

Answer 4

age
- systematic relationship where you save more as you age
- expect more wealth when people are older

inheritances

saving propensity
- some consume everything they earn

rate of return

Question 5

three basic approaches to capital income and wealth taxation in the US

Answer 5

annual taxes on capital income (biggest category)

annual taxes on wealth

wealth transfer taxes (gifts and inheritances)

Question 6

individual income tax

Answer 6

progressive marginal tax rate schedule

some income like interest taxed at the same rate as labour income

Question 7

corporate income tax

Answer 7

21% flat rate tax

not imposed on other types of businesses (partnerships, sole proprietorships, etc.) or on S corporations (legal corporations with restrictions regarding share ownership)

Question 8

annual wealth tax: property taxes

Answer 8

based on asset values

applied to residential/commercial real estate

separate taxes on other assets like vehicles

Question 9

wealth transfer taxes: estate and gift taxes

Answer 9

top marginal tax rate of 40%

federal tax rate applies over a very high threshold value of estate so affects very few decedents

Question 10

determinants of saving

Answer 10

income and substitution effect based on the rate of return

Question 11

basic theory of saving - life-cycle model

Answer 11

individuals save during peak earning years to provide resources for the future

Question 12

substitution effect of capital income taxes on savings

Answer 12

lower after-tax interest rates cause first-period consumption to rise, reducing savings

Question 13

income effect of capital income taxes on savings

Answer 13

lower after-tax interest rates reduce the lifetime value of income, reducing first-period consumption and increasing savings

Question 14

evidence on substitution/income effects of taxes on savings

Answer 14

responsiveness may not be high but if it’s not 0, substitution effect dominates

higher taxes lead to less saving, but not necessarily very strongly

Question 15

other models of saving

Answer 15

precautionary saving: individuals with uncertain income have higher savings rates

self-control issues: people want to save more than they do

passive vs. active saving: individuals participate in employer-based retirement accounts where they save an amount determined by their lawyer rather than by themselves

Question 16

retirement saving

Answer 16

401k plan: employer-based retirement account

individual retirement account (IRA)
- traditional where you don’t pay tax until you withdraw but you get tax expenditures when putting money in (deduction for savings)
- Roth where there is a 0% tax on savings but no tax deduction

Question 17

how should retirement saving incentives affect saving?

Answer 17

usual income and substitution effects with reduced tax rate

annual contributions capped, so individual who wants to save more is subject to regular taxation on additional saving

contributions don’t require new saving and individuals can transfer savings

Question 18

evidence from denmark on retirement savings

Answer 18

natural experiment arising from a change in retirement account rules and taxation
- reduction in 1999 in the tax subsidy to savings for taxpayers in the top bracket but not below that level

contributions fell dramatically for higher-income taxpayers and din’t change for the lower-income group
- reduced savings incentives

reduction in contributions doesn’t imply reduction in savings
- offset by increase in other types of savings