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Standard optimal capital tax theory abstracts from modeling asset prices, making it unsuitable for thinking about capital gains and wealth taxation. We study optimal redistributive taxation in an environment with asset price movements, adopting the modern finance view that asset prices fluctuate not only because of changing cash flows, but also due to other factors (“discount rates”). We show that a combination of realization-based capital gains and cash flow taxes implements the optimal allocation regardless of the source of asset-price fluctuations. Moreover, the capital gains tax avoids distortions in portfolio choice (the socalled lock-in effect) by targeting total net trades rather than gains from selling individual assets. These results stand in contrast to the classic Haig-Simons comprehensive income tax concept as well as recent proposals for wealth or accrual-based capital gains taxes.
Wealth taxes lose the comparison. That is from Econometrica, by Mark Aguiar, Benjamin Moll, and Florian Scheuer.
