Capital taxation is great. In the Netherlands, there is a strange capital tax scheme though. In 2001, lawmakers revised the Dutch laws on income taxation. In the new law, it was agreed upon to set a capital income tax of 30%. Lawmakers made the assumption that annual return on capital would be around 4%, and thus came up with the idea to set a tax of 1.2% (at which they arrived by taking 30% of 4%) on a citizen's average capital.
There are two reasons why I oppose such a scheme. First, a fixed tax on capital works pro-cyclic. Second, such a tax scheme favors the very wealthy.
##Pro-cyclic tendencies It is pretty obvious that having capital tax costs that are quite steady over time, means that the tax burden relative to income increases in times of economic downturn, and falls in times of economic growth. Let's focus on what happens during economic decline. As the relative tax burden increases, consumers have less money to spend. The reduced spending in turn further depresses economic activity. These effects feed a vicious cycle to economic dispair. The fact that for citizens the effects of a steady capital tax are destabilizing, means that for the treasury department such a scheme is stabilizing. Namely, regardless of economic activity, its income from capital taxation will be rather steady. This means that government spending can be pretty much maintained without attracting additional financial resources. This would promote the use of Keynesian fiscal policies to combat crises. Now we should ask the question whose stability the economy as a whole benefits most from. There is no easy answer. My answer would be three-fold.
- A government should assume its citizens are myopic agents that, due to numerous heuristics, are unable to set up solid forward-looking personal financial plans. Governments, on the other hand, should be able to manage the treasury more responsible. Given the access to expertise, a government should be able to make financial decisions more rationally, and should be less subject to the heuristics that affect its citizens. Thus, in theory a government would be better able to build up reserves during periods of prosperity, which are available for use during crises.
- For anti-cyclic fiscal policies, governments do not have to rely solely on tax income; they have access to alternative sources for funding their anti-cyclic policies. For example, governments can issue additional sovereign debt. Note that this doesn't hold if governments face a sovereign debt crisis, but in my view this should be no issue for the majority of responsible governments.
- Due to the slowness that is involved with political decision making, even if a government dares to adopt Keynesian policies during crises, implementation is often lagging. On the other hand, citizens pay capital taxes on a more frequent basis. This leads to a situation where the relative increase in capital tax expenditure has already been feeding a depressive vicious cycle, before government comes crashing in with anti-cyclic policies to break it. If the vicious cycle would not have been fed in the first place, perhaps there would not have been a depression at all and government intervention would not even have been necessary.
##Favoring the super rich The explanation of why such a tax scheme favors the very wealthy is a bit more complicated. Details will follow.