Preference Heterogeneity and Optimal CapitalIncome Taxation

We analytically and quantitatively examine a prominent justi…cation for capital income taxation: goodspreferred by those with high ability ought to be taxed. We study an environment where commodity taxesare allowed to be nonlinear functions of income and consumption and …nd that, when ability is positivelyrelated to a preference for a good, optimal marginal commodity taxes on this good may be regressive: i.e.,declining with income. We derive an analytical expression for optimal commodity taxation, allowing us tostudy the forces for and against regressivity. We then parameterize the model to evidence on the relationshipbetween skills and preferences and examine the quantitative case for taxes on future consumption (saving).The relationship between skill and time preference delivers quantitatively small, generally regressive capitalincome taxes and would justify only a fraction of the prevailing level of capital income taxation.[...]