NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Taxation of Interest Income

Roger H. Gordon

NBER Working Paper No. 9503
Issued in February 2003
NBER Program(s):   PE

Why is interest income taxed more heavily than other forms of capital income? This differential tax treatment has generated substantial tax arbitrage, resulting in lower tax revenue, efficiency costs, and apparently net gains to rich borrowers and net losses to poor lenders, together suggesting that this tax treatment makes no sense on welfare grounds. In examining this argument more formally, this paper reveals two omitted considerations that can help explain the existing tax treatment. First, the forecasted increase in the market interest rate results in a redistribution from rich borrowers to poor lenders. Yet this redistribution comes at no marginal efficiency cost, starting from a situation with no distortions to portfolio choice, so at the margin dominates further redistribution through the income tax. In addition, information about an individual's portfolio choice reveals information about her earnings ability, even controlling for observed labor income, if those who are more able tend to be less risk averse. By making use of this extra information about earnings ability, the tax system can be better tailored to redistribute from able to less able, for any given efficiency cost.

download in pdf format
   (238 K)

email paper

This paper is available as PDF (238 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w9503

Published: Gordon, Roger H. "Taxation Of Interest Income," International Tax and Public Finance, 2004, v11(1,Jan), 5-15.

Users who downloaded this paper also downloaded these:
Kearney w11234 The Economic Winners and Losers of Legalized Gambling
Wolfers w10014 Did Unilateral Divorce Laws Raise Divorce Rates? A Reconciliation and New Results
Lamoreaux and Rosenthal w10288 Legal Regime and Business's Organizational Choice: A Comparison of France and the United States
Autor, Donohue, and Schwab w9425 The Costs of Wrongful-Discharge Laws
Shavell w10094 On the Writing and the Interpretation of Contracts
 
Publications
Activities
Meetings
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us