How does wealth taxation differ from capital income taxation? In this paper Guvenen et al. (2019) use a rich quantitative general equilibrium model with rate of return heterogeneity to show that there are large welfare gains from replacing capital income taxes with wealth taxes.
They study this question theoretically and derive conditions under which switching from capital income taxes to wealth taxes increases efficiency, aggregate output, wealth inequality, and welfare. For this purpose, they use a simplified version of the model but keeping the following two key ingredients: the heterogeneity in entrepreneurial productivity and financial frictions that prevent the free flow of funds across entrepreneurs, allowing some entrepreneurs to earn higher returns on wealth than others.
First, they show that switching from a capital income tax to a wealth tax increases aggregate efficiency and output if and only if entrepreneurial productivity is persistent. In that case, the tax reform reallocates wealth towards more productive entrepreneurs, increases the dispersion in rates of return and increases wealth inequality.
Second, under mild restrictions on the capital income share (greater than 1/3) in the entrepreneurial production function, the tax reform also improves aggregate welfare.
Finally, they study optimal taxation in this framework.