How Well Does a Cash-Flow Tax on WagesApproximate an Economic Income Taxon Labor Income?

The recent German discussion has witnessed increasing interest in the Dual IncomeTax. The analysis of its merits, as opposed to those of a comprehensiveincome tax, is usually conducted with the main argument of the increasing mobilityof financial capital in mind. This article pursues an alternative route ofreasoning, arguing that the composition of the tax base of labor income entails adifferentiation of the tax rates on capital and labor income. The time effect inherentin this dualism causes allocational distortions of unknown magnitude. It ismodeled employing effective tax rates. The extent of the divergence is determinedempirically, using German cross-sectional data from the 2004 wave of the Socio-Economic Panel‡. The uneven distribution of this advantage across differentlyeducated brackets of society is uncovered. The paper concludes with proposalsto remedy the situation and a tentative endorsement of the Dual Income Tax.