Taxation of Interest Income

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Taxation of Interest Income

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Roger Gordon ()

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Roger H. Gordon

Abstract

Why is interest income taxed so much more heavily than other forms of capital income? This differential tax treatment has generated substantial tax arbitrage, resulting in lower tax revenue, efficiency costs, and apparently net gains to rich borrowers and net losses to poor lenders, together suggesting that this tax treatment makes no sense on welfare grounds. In examining this argument more formally, this paper reveals two omitted considerations that can help explain the existing tax treatment. First, the forecasted increase in the market interest rate results in a redistribution from rich borrowers to poor lenders. Yet this redistribution comes at no marginal efficiency cost, starting from a situation with no distortions to portfolio choice, so at the margin dominates further redistribution through the income tax. In addition, information about an individual's portfolio choice reveals information about her earnings ability, even controlling for observed labor income, if those who are more able tend to be less risk averse. By making use of this extra information about earnings ability, the tax system can be better tailored to redistribute from able to less able, for any given efficiency cost. Copyright Kluwer Academic Publishers 2004

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Publisher Info
Article provided by Springer in its journal International Tax and Public Finance.

Volume (Year): 11 (2004)
Issue (Month): 1 (January)
Pages: 5-15
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Handle: RePEc:kap:apfinm:v:11:y:2004:i:1:p:5-15

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Paper
- Roger H. Gordon, 2003. "Taxation of Interest Income," NBER Working Papers 9503, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

Atkinson, A. B. & Stiglitz, J. E., 1976. "The design of tax structure: Direct versus indirect taxation," Journal of Public Economics, Elsevier, vol. 6(1-2), pages 55-75. [Downloadable!] (restricted)
Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Blackwell Publishing, vol. 38(114), pages 175-208, April. [Downloadable!] (restricted)
Emmanuel Saez, 2000. "The Desirability of Commodity Taxation under Non-Linear Income Taxation and Heterogeneous Tastes," NBER Working Papers 8029, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
Other versions:
- Saez, Emmanuel, 2002. "The desirability of commodity taxation under non-linear income taxation and heterogeneous tastes," Journal of Public Economics, Elsevier, vol. 83(2), pages 217-230, February. [Downloadable!] (restricted)
Gordon, Roger H, 1985. "Taxation of Corporate Capital Income: Tax Revenues versus Tax Distortions," The Quarterly Journal of Economics, MIT Press, vol. 100(1), pages 1-27, February.
Roger H. Gordon & Joel Slemrod, 1989. "Do We Collect Any Revenue From Taxing Capital Income?," NBER Reprints 1214, National Bureau of Economic Research, Inc.

Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

Stefania Albanesi, 2006. "Optimal Taxation of Entrepreneurial Capital with Private Information," NBER Working Papers 12419, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
Other versions:
- Stefania Albanesi, 2006. "optimal taxation of entrepreneurial capital with private information," 2006 Meeting Papers 310, Society for Economic Dynamics. [Downloadable!]
- Albanesi, Stefania, 2006. "Optimal Taxation of Entrepreneurial Capital with Private Information," CEPR Discussion Papers 5647, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
- Stefania Albanesi, 2007. "Optimal taxation of entrepreneurial capital with private information," Discussion Papers 0607-11, Columbia University, Department of Economics. [Downloadable!]
David Hargreaves, 2008. "The tax system and housing demand in New Zealand," Reserve Bank of New Zealand Discussion Paper Series DP2008/06, Reserve Bank of New Zealand. [Downloadable!]

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