Preference Heterogeneity and Optimal Capital Taxation

We analytically and quantitatively examine a prominent justification forcapital income taxation: goods preferred by those with high ability ought tobe taxed. We study an environment where commodity taxes are allowed to benonlinear functions of income and consumption and find that, when ability ispositively related to a preference for a good, optimal marginal commoditytaxes on this good may be regressive: i.e., declining with income. We derivean analytical expression for optimal commodity taxation, allowing us to studythe forces for and against regressivity. We then parameterize the model toevidence on the relationship between skills and preferences and examine thequantitative case for taxes on future consumption (saving). The relationshipbetween skill and time preference delivers quantitatively small, generallyregressive capital income taxes and would justify only a fraction of theprevailing level of capital income taxation.[...]