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Capital Income Taxes With Heterogeneous Discount Rates

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  • Peter Diamond
  • Johannes Spinnewijn

Abstract

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 savings can 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 to switch 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. This can be implemented by earnings varying rules on contributions to tax-favored retirement accounts. However, introducing a uniform savings tax, as in the Nordic dual income tax, increases welfare only if that correlation is succinctly high. There are also some results on optimal taxes that parallel the results on introducing small taxes.

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Bibliographic Info

Paper provided by Center for Retirement Research in its series Working Papers, Center for Retirement Research at Boston College with number wp2009-14.

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Length: 34 pages
Date of creation: Jun 2009
Date of revision: Jun 2009
Handle: RePEc:crr:crrwps:wp2009-14

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References

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  1. Narayana R. Kocherlakota, 2003. "Zero Expected Wealth Taxes: A Mirrlees Approach to Dynamic Optimal Taxation," Levine's Bibliography 666156000000000426, UCLA Department of Economics.
  2. Sören Blomquist & Vidar Christiansen, 2004. "Taxation and Heterogeneous Preferences," CESifo Working Paper Series 1244, CESifo Group Munich.
  3. Christopher F. Chabris & David Laibson & Carrie L. Morris & Jonathon P. Schuldt & Dmitry Taubinsky, 2008. "Individual Laboratory-Measured Discount Rates Predict Field Behavior," NBER Working Papers 14270, National Bureau of Economic Research, Inc.
  4. Karen E. Dynan & Jonathan Skinner & Stephen P. Zeldes, 2000. "Do the rich save more?," Finance and Economics Discussion Series 2000-52, Board of Governors of the Federal Reserve System (U.S.).
  5. Ritva Tarkiainen & Matti Tuomala, 2007. "On optimal income taxation with heterogeneous work preferences," International Journal of Economic Theory, The International Society for Economic Theory, vol. 3(1), pages 35-46.
  6. 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.
  7. Katherine Cuff, 1998. "Optimality of Workfare with Heterogeneous Preferences," Working Papers 968, Queen's University, Department of Economics.
  8. BOADWAY, R. & MARCHAND, M. & PESTIEAU, P. & del MAR RACIONERO, M., 2001. "Optimal redistribution with heterogeneous preferences for leisure," CORE Discussion Papers 2001025, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  9. Diamond, Peter, 2006. "Optimal tax treatment of private contributions for public goods with and without warm glow preferences," Journal of Public Economics, Elsevier, vol. 90(4-5), pages 897-919, May.
  10. Louis Kaplow, 2008. "Optimal Policy with Heterogeneous Preferences," NBER Working Papers 14170, National Bureau of Economic Research, Inc.
  11. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 175-208, April.
  12. 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.
  13. Roger Gordon, 2004. "Taxation of Interest Income," International Tax and Public Finance, Springer, vol. 11(1), pages 5-15, January.
  14. Roger H. Gordon & Wojciech Kopczuk, 2014. "The Choice of the Personal Income Tax Base," NBER Working Papers 20227, National Bureau of Economic Research, Inc.
  15. Kaplow Louis, 2008. "Optimal Policy with Heterogeneous Preferences," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 8(1), pages 1-30, September.
  16. Peter A. Diamond, 2005. "Taxation, Incomplete Markets, and Social Security," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262541823, December.
  17. Chabris, Christopher F. & Laibson, David I. & Morris, Carrie L. & Schuldt, Jonathon P. & Taubinsky, Dmitry, 2008. "Individual Laboratory-Measured Discount Rates Predict Field Behavior," Scholarly Articles 11130522, Harvard University Department of Economics.
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Citations

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Cited by:
  1. Peter Diamond, 2009. "Taxes and Pensions," Southern Economic Journal, Southern Economic Association, vol. 76(1), pages 2-15, July.
  2. Matthew C. Weinzierl, 2012. "The Promise of Positive Optimal Taxation," NBER Working Papers 18599, National Bureau of Economic Research, Inc.
  3. Sule Alan & Kadir Atalay & Thomas F. Crossley, 2006. "Do the Rich Save More in Canada?," Social and Economic Dimensions of an Aging Population Research Papers 153, McMaster University.
  4. Jang-Ting Guo & Alan Krause, . "Dynamic Nonlinear Income Taxation with Quasi-Hyperbolic Discounting and No Commitment," Discussion Papers 11/16, Department of Economics, University of York.
  5. Kuhle, Wolfgang, 2012. "Dynamic efficiency and the two-part golden rule with heterogeneous agents," Journal of Macroeconomics, Elsevier, vol. 34(4), pages 992-1006.
  6. Bas Jacobs, 2013. "From Optimal Tax Theory to Applied Tax Policy," CESifo Working Paper Series 4151, CESifo Group Munich.
  7. Benjamin B. Lockwood & Matthew C. Weinzierl, 2012. "De Gustibus non est Taxandum: Heterogeneity in Preferences and Optimal Redistribution," NBER Working Papers 17784, National Bureau of Economic Research, Inc.
  8. Matti Tuomala & Sanna Tenhunen, 2013. "On the design of an optimal non-linear tax/pension system with habit formation," International Tax and Public Finance, Springer, vol. 20(3), pages 485-512, June.

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