Writing at Marginal Revolution, Tyler Cowen highlights a new paper published in Econometrica by Mark Aguiar, Benjamin Moll, and Florian Scheuer, titled "Putting the Finance into Public Finance: A Theory of Capital Gains Taxation." Econometrica is one of the leading peer-reviewed journals in economics, and the paper sits squarely within a live policy debate: several U.S. proposals in recent years have called for taxing unrealized capital gains or imposing annual wealth taxes, and a number of European countries have experimented with wealth taxes, with several—notably France, Germany, and Sweden—repealing or scaling them back in recent decades.

The paper's abstract reads as follows:

Standard optimal capital tax theory abstracts from modeling asset prices, making it unsuitable for thinking about capital gains and wealth taxation. The authors 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"). They 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 so-called 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.

The "lock-in effect" referenced in the abstract is a long-standing concern in tax policy: when capital gains are taxed only upon sale, investors have an incentive to hold appreciated assets to defer the tax, which can distort portfolio allocation. The paper's contribution is to show how a capital gains tax designed to target total net trades, rather than gains on individual asset sales, can sidestep that problem.

Cowen's conclusion from the paper: "Wealth taxes lose the comparison."

Source: Marginal Revolution, Capital gains vs. wealth taxes. Paper: Econometrica, forthcoming.