Use It or Lose It: Efficiency and Redistributional Effects of Wealth Taxation*.

This article examines the differences between wealth taxation and capital income taxation in the presence of persistent heterogeneity in returns on investment, using a calibrated overlapping-generations model matched to U.S. data. It finds that, unlike the traditional equivalence result assuming homogeneous returns, wealth taxation reallocates capital toward more productive entrepreneurs by taxing wealth uniformly regardless of productivity, thereby improving aggregate productivity, output, and welfare. Optimal taxation analysis shows a positive optimal wealth tax combined with a lower labor tax yields larger welfare gains and reduces inequality, whereas the optimal capital income tax is a negative tax (subsidy) accompanied by higher labor taxes, resulting in lower welfare and increased inequality. Transition path analysis further indicates that wealth taxation delivers robust welfare gains across cohorts, while capital income subsidies cause significant welfare losses during adjustment. The study highlights that broad-based, book-value–based wealth taxes replacing capital income taxes may be a more efficient and equitable policy alternative, though practical implementation challenges remain unaddressed.