Analyzing the Optimal Choice of Tax Instruments: The Case for Levying (all of) Labor-Income Taxes, Value-Added Taxes, Capital-Income Taxes, and Wealth Taxes

Source: David Gamage, University of California, Berkeley Public Law Research Paper No. 2465522, July 14, 2014

From the abstract:
Economic analyses of taxation have largely focused on the problems of labor-to-leisure and saving-to-spending distortions. Based on these analyses, the prior literature has generally treated labor-income and consumption taxes as being essentially equivalent, and has also treated capital-income and wealth taxes as being essentially equivalent. Further, based on these analyses, the dominant view in the prior literature has been that neither capital income nor wealth should be taxed.

This Article expands on these prior analyses by incorporating a variety of tax-gaming responses and also administrative and compliance costs. By doing so, this Article argues that it is probably optimal for governments to levy some version of (all of) labor-income taxes, value-added taxes, capital-income taxes, and wealth taxes.

In light of empirical evidence suggesting that taxpayers engage in a variety of tax-gaming distortions, this Article argues that the theoretical equivalencies between (i) labor-income and consumption taxes, and (ii) capital-income and wealth taxes, are unlikely to hold with respect to real-world implementations of these tax instruments. Furthermore, this Article argues that the prior theoretical arguments about the desirability of taxing capital income have only limited applicability to the real-world tax instruments commonly labeled as “capital-income taxes” and that it is probably optimal to levy real-world capital-income taxes to at least some degree.