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NRO’s domestic-policy blog, by Reihan Salam.

Dylan Matthews on the Logic Behind Preferences for Capital Income



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Dylan Matthews of Wonkbook explains that one of the main reasons capital income is taxed at lower rates is that “the effects of taxing savings can be a little weird”:

[Emmanuel] Saez and [Peter] Diamond imagine that there’s a 30 percent tax on income, whether or not it’s saved. They then imagine you save that money for 40 years, and earn 5 percent interest every year. If savings weren’t taxed at all, then you could take that money out after 40 years and pay the 30 percent rate. But if the savings were taxed before it was saved and after it’s pulled out, the total rate comes to a staggering 73.8 percent. So there is, in effect, a massive incentive to spend money now rather than save it and spend it later on.

Some economists argue that this means there shouldn’t be any tax on capital, because as the number of years you save approaches infinity, the tax rate on savings starts to become truly exorbitant. But Saez and Diamond (as well as Saez and Thomas Piketty in another paper) note that this only makes sense if you assume people live as though they’re immortal.

Matthews also references the case Greg Mankiw, Matthew Weinzierl and Danny Yagan have made for eliminating taxes on capital.  



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