I Will Survive: Capital Taxation, Voter Turnout and Time Inconsistency

Abstract

This paper reconsiders the debate around the political determination of capital income taxes and explains why such taxes survive in most OECD countries. The political economy literature on redistributive politics (Persson and Tabellini 2003) emphasizes the role played by the lower class in the political arena: being labor more concentrated than capital, the majority of the population benefits by overtaxing capital and undertaxing labour. However, in reality, political participation (voting, lobbying, protesting etc.) is positively correlated with income. Therefore, a paradoxical result emerges: why do the upper class, who is politically more active and own most of the capital, still favour a positive capital tax? Hence, voters' income is not the sole relevant variable in the political determination of the capital tax. To reconcile this apparent puzzle, we propose a model that incorporates time inconsistency à la Laibson in individual preferences We show that time inconsistent individuals are politically more homogeneous (or “single-minded”) than far-sighted, and prefer to tax more capital income, instead of labor income, since accumulated saving are below the planned (and optimal) level and the distortionary effects of a higher capital tax are not only reduced but also delayed in time. We demonstrate that, since politicians find easier to please hyperbolic voters by proposing a tax policy that includes lower labor and higher capital taxes compared to an economy with only far sighted. Moreover, we show that, as the proportion of time inconsistent individuals in the population increases, the tax policy becomes more and more biased towards capital taxation.Political Economy, Multidimensional Voting, Capital Taxation, Redistribution, Hyperbolic Discounting