Taxing capital gains

Capital gains are by far the most important source of income and wealth for the richest households, and they have reached record levels in recent years. At the same time, they are treated favorably by many advanced countries’ tax systems relative to other forms of income. This has raised concerns about the overall progressivity of the tax system and put the question as to the optimal taxation of capital gains at the center of policy discussions about rising inequality, notably at the top. While the household finance literature has recently developed, based on novel empirical evidence, more realistic models of the origins of capital gains and their heterogeneity across households, their normative implications are still largely unexplored. This project will incorporate such progress into the design of tax policy. It will ask: (i) What are the welfare effects of capital gains depending on whether they are the result of asset price changes due to shifts in interest rates as opposed to shifts in expected future asset returns (such as dividends or profits)? (ii) What is the role of inequality in individuals’ portfolio balances and maturities? (iii) Which system of capital gains taxation is preferable depending on the sources of capital gains? In addition to a theoretical analysis, the goal is to build a full-fledged asset pricing model incorporating secular trends in interest rates and the distribution of capital gains, and to explore their implications for taxation quantitatively.