The Right Tax at the Right Time

Abstract

The companion paper to this (Capital Taxation in an Age of Inequality) argues that a moderate flat rate (proportional) income tax on capital, measured and collected annually, has attractive theoretical and political economy properties that can be harnessed in actual tax instrument design. This Article continues the analysis by specifying in detail how such a tax might be designed.

The idea of the Dual Business Enterprise Income Tax, or Dual BEIT, is to offer business enterprises a neutral profits tax environment in which to operate. To do so, normal returns to capital are exempt from tax by means of an annual capital account allowance, termed the Cost of Capital Allowance (COCA). In turn, investors in firms include in income each year the same COCA rate, applied to their respective tax bases in their investments. The result is a single tax on capital income (rents plus normal returns), where the tax on normal returns is imposed directly on the least mobile class of taxpayers. Labor income continues to be taxed at progressive tax rates.

This Article develops in detail the design of the Dual BEIT, at a level of specificity that permits readers to judge the real-world plausibility of the proposal.† In doing so, the Article focuses particularly closely on three design issues. First, because labor is taxed at progressive rates and the top rate exceeds the capital income tax rate, the Dual BEIT must specify a labor-capital income tax centrifuge to tease apart labor from capital income when the two are intertwined in respect of the owner-entrepreneur of a closely held firm. Second, the Article considers the theory and practice behind the choice of the COCA rate: that is, the Article inquires into just what should be meant by a “normal” return to capital. Third, the Article specifies an international tax regime that should be attractive to firm managers yet robust to stateless income gaming.

Throughout, the emphasis is on developing pragmatic technical solutions that are implementable without profound transition issues, that are administrable, and that fairly balance theoretical desiderata against political economy realities.

Note: This Article was prepared prior to the consideration by Congress in late 2017 of the Tax Cuts and Jobs Act (TCJA). The Article therefore does not address any of the provisions of that legislation. In general, however, the TCJA can be summarized as a useful example of capital income tax reform done exceedingly badly.