Redistributive capital taxation revisited
What is this research about and why did you do it?
We analyze the role of capital-skill complementarity (CSC) on optimal redistributive taxation within a rich quantitative environment. CSC means the degree of complementarity between capital and skilled labor is higher than that of between capital and unskilled labor. Although empirical evidence supports the presence of CSC in the production process, most papers do not consider this evidence. We highlight an additional redistributive benefit of taxing capital under CSC arisesfrom the relationship between capital accumulation and the skill premium: a higher capital stock raises the skill premium, unlike in standard models whereit is unaffected by capital.
How did you answer this question?
To assess the role of CSC in the optimal capital income taxation, we compare two economies differing only in their production functions: one with CSC (Krusellet al. 2000) and the other with a standard Cobb-Douglas function. Both economies feature endogenous skill acquisition and incomplete markets with idiosyncratic labor income risk, enabling us matching earnings and wealth inequality—crucial for evaluating redistributive effects of capital taxation. We calibrate each economy to the U.S. and consider a Utilitarian government setting a linear capital income tax, and potentially adjusting labor tax progressivity during the transition.
What did you find?
We show that CSC provides a strong rationale for taxing capital for redistributive governments: taxing capital reduces the skill premium enabling indirect redistribution from skilled(who earn more and hold more assets) to unskilled workers. We find it is optimal to raise capital income taxes and lower labor income taxes when CSC is taken into account: In the baseline tax reform, the optimal capital income tax rate under CSC is 6pp higher than in the Cobb-Douglas economy. The skill premium falls significantly during the transition, while it remains unchanged in the CD case. Welfare gains from optimal tax reform are notably larger under CSC (Table 1).
What implications does this have for the study (research and teaching) of wealth concentration or economic inequality?
Our research contributes to the debate on optimal capital taxation by quantifying the redistributive effects of CSC. Given strong empirical evidence of CSC in production, alongside rising earnings and capital ownership inequality, our analysis suggests that governments should consider these complementarities when setting capital tax rates. Our research points out that it is optimal to rely more on capital income taxes and less on labor income taxes when CSC is accounted for.
What are the next steps in your agenda?
Our findings underscore the importance of capital-labor relations in designing fiscal policy. With recent technological advancements, particularly in automation, my agenda centers around analyzing how these technologies and fiscal policy interact, given the potential to address rising earnings and wealth inequalities.
Citation and related resources
Kina, Ö., Slavík, C. ad Yazici, Y. (2024). Redistributive Capital Taxation Revisited. American Economic Journal: Macroeconomics, 16 (2):182–216. April 2024.
Krusell, P., Ohanian, L. E., Rios-Rull, J, V. and Violante, G. L. (2000). Capital-Skill Complementarity and Inequality: A Macroeconomic Analysis.
Econometrica, 68(5): 1029-1054. September 2000.
