Optimal Capital Taxation When Individuals Have Different Rates of Return

Stiglitz (1985) and Piketty (2014) conjectured that capital income should be optimally taxed when individuals have different rates of return on their assets. This paper proves their conjectures right by analyzing the optimal setting of labor and capital taxes and by analyzing tax reforms that raise capital taxes to cut labor taxes. We demonstrate that besides taxes on labor income taxes on capital income are desirable, despite our assumption that preferences satisfy the weak separability conditions of the Atkinson-Stiglitz (1976) theorem.