The answer is: we should tax capital income. This conclusion is derived by analyzing taxes on capital income and wealth in a standard two-period portfolio model with safe and risky assets with either idiosyncratic, individual risk or systematic, aggregate risk. Compensated tax reforms are analyzed where taxes on capital income are increased, while taxes on wealth are decreased. Such tax reforms are found to be welfare improving because taxes on capital income impose a non-distorting tax on the risk-premium, whereas taxes on wealth do not. Hence, for the same distortions, taxes on capital income generate more revenue than taxes on wealth. Optimal taxes on capital income and wealth are derived.

We study how a wealth tax and a realization-based capital gains tax affect capital market efficiency. We develop a two-period model with investors that are heterogeneous in both the value of an initial investment, and the future return on the initial investment. We show that the realization-based capital gains tax reduces the required rate of return on existing investment below the required rate of return on new investments, resulting in lock-in. A comprehensive wealth tax can eliminate this lock-in effect. We then develop an optimal-tax model that trades of equity gains from the capital-gains and wealth tax to efficiency losses related to intertemporal choice, and lock-in. We derive a criterion for the desirability of a wealth tax based on elasticities that can be estimated empirically. In addition, we find an upper bound on the optimal wealth tax. Finally, we consider an extension where long-run capital gains partially escape taxation.

For the coming years, the government in the Netherlands has announced a reform of the capital tax scheme: from the current scheme that taxes financial wealth towards a scheme that taxes capital income. This paper explores the economic and welfare effects of such a reform. I adopt different assumptions on the use of tax revenues, on household heterogeneity and on access to capital markets. In representative-agent versions of the model, the reform is found to be welfare-improving. In those versions that distinguish low wealth households from high wealth households, the reform continues to benefit the latter. Low wealth households, however, may be worse off on account of increased income volatility.

This paper revisits the debate on the welfare impacts of capital taxation, particularly challenging the prevailing notion that such taxes are universally harmful. Our study concentrates on estate taxation and investigates its welfare effects in an overlapping-generations (OLG) model, which uniquely incorporates a bequest motive. We introduce an innovative segregated economy model, delineating households into two distinct categories: workers and capitalists. This distinction allows us to uncover that the implications of estate taxes vary significantly based on whether households primarily rely on labor income or on inherited wealth. Also, for both cases, the effects of age-dependent inheritance taxes are very sensitive to the substitutability of bequests to children and bequests to grandchildren. Our results indicate that the after-tax rate of return on capital is not solely determined by traditional discount rates but is also significantly influenced by estate tax rates and the nature of bequest motives.