Kevin Spiritus: Optimal Taxation of Risky Capital Income: the Rate of Return Allowance
OFS seminar. Kevin Spiritus is a PhD candidate the KU Leuven University in Belgium. He will present a paper entitled "Optimal Taxation of Risky Capital Income: the Rate of Return Allowance", written jointly with Robin Boadway.
Photo: Sophie Soete
Kevin Spiritus will present his paper «Optimal Taxation of Risky Capital Income: the Rate of Return Allowance», coauthored with Robin Boadway.
We study the optimality of taxing capital income according to a Rate of Return Allowance (RRA) proposed by the Mirrlees Review  alongside a nonlinear tax on earnings. In this proposal, risk-free returns on all assets are tax-exempt, while excess returns on risky assets face a positive tax rate and a nonlinear income tax applies to earnings. We adopt a setting in which capital income would be tax-exempt if all assets were risk-free and earned competitive returns. Households allocate their savings among a risk-free asset, a market portfolio subject to aggregate risks and private investments subject to idiosyncratic risk. In an optimum, the tax on risk-free returns should be zero if the mean-variance framework applies with constant returns to scale in private investment, but positive with decreasing returns to scale, and vice versa. The tax rate on risky returns will be between zero and 100% if the stochastic tax revenue is returned to the household by variable public good provision. If they are returned as a stochastic lump sum, the optimal tax on excess returns will be irrelevant if there is only aggregate risk, and it will approach 100% if there is also idiosyncratic risk. The same pattern emerges when the government has both a stochastic lump sum and a stochastic public good at its disposal. These instruments are then chosen in such a way that private risk is balanced against public risk. Optimal margin earnings tax rates in each of these cases are adjusted to take account of their indirect effect on capital income tax revenues. An equity- and risk-adjusted Samuelson rule for public goods applies and also incorporates induced effects on capital income tax revenues.