Wednesday, March 17, 2010

Within healthcare reform, a push to tax the rich

Christian Science Monitor article "Within healthcare reform, a push to tax the rich" (March 13th, 2010) describes as an incidental note a mastodonically foolish piece of the Obama medicare reform. It notes that one of the administration's new taxes is a tax on capital gains.

Obama would boost the Medicare tax by 0.9 percentage points for households with incomes over $200,000 for singles and $250,000 for joint filers. In addition, he’d impose a 2.9 percent tax on these same people on interest, dividends, annuities, and most other investment income. While the official Obama summary does not say so, the new tax would apply to capital gains as well.

Individual households supply capital. They enjoy consuming today rather than tomorrow. They are only willing to put off consumption today until tomorrow if they are paid for it--otherwise, they consume today. This is due to their discount rate, a primitive that is largely taken as given. Their discount rate does not change, and therefore, household supply of capital is perfectly elastic. If this is the case, then the whole incidence of a tax falls on the firm. However, both households and firms are able to relocate. In this case, government taxation of capital is optimally zero as it only harms production and raises little in taxes. The drastic impact taxation can have when both supply and demand are relatively elastic is graphically displayed below (click to enlarge).

This result is given relatively robustly by Andrew Atkeson, V.V. Chari and Patrick J. Kehoe, in "Taxing Capital Income: A Bad Idea" (Federal Reserve Bank of Minneapolis Quarterly Review, 1999). To quote the paper, "The intuition for why optimal source-based taxes are zero is that with capital mobility, each government faces a perfectly elastic supply of capital as a factor input and therefore optimally chooses to set capital income taxes on firms to zero."

In the hamartiology of economics, there are cardinal and venial sins. The taxation of capital is a cardinal sin.

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