Taxing Wealth Unlocks Capital Gains: An Efficiency Rationale for Wealth Taxes

Realization-based capital income taxation generates capital lock-in because investors have an incentive to delay tax payments. This generates inefficiency as investors forgo investment opportunities that require them to realize capital gains. We show that wealth taxation can unlock capital, eliminating the distortion on investors’ portfolio choice. Moreover, wealth taxes do not distort this choice in the absence of capital income taxation. This provides an efficiency rationale for wealth taxation independent of equity: shifting revenues from capital income to wealth taxes reduces distortions on portfolio choice. We provide conditions for the optimal tax mix between capital income and wealth taxes that balance the equity gains from both taxes against efficiency losses related to savings and portfolio choices. These conditions hinge on the cross-base elasticity of capital income to wealth taxes which captures lock-in responses.