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To elaborate, as interest rates increase, capital’s opportunity cost increases. Capital requires a higher overall gain from equity to compete with the higher passive interest income. Increasing taxes on capital increases the chance of capital consumption. If an industry is faced with capital consumption by decree, there is only one strategy, a staged retreat strategy. Production ultimately halts. Hence, capital taxes divert resources from productive activities to passive, debt-yielding types of activities.

https://mises.org/wire/taxing-capital-leads-capital-consumption

Daniel Moule

The Misesian tradition provides essential insights into the nature of capital. From Frédéric Bastiat to Murray N. Rothbard, Austrian capital theory excels.

Bastiat illustrated gains from capital by giving us the anecdote of the neighbor who wanted to borrow a timber planer. Rothbard gave us the examples of royalties in the extractive industry to illustrate capital consumption. The list goes on. Often, capital’s exceptional output is because it behaves as both nonlinear and time specific.

Historically, societies have been reluctant to tax gains from capital. For example, capital gains tax was only introduced in Australia in the mid-1980s. Many of the gains from capital assets continue to receive favorable tax treatment.

The Laffer curve attempts to model government revenue against a taxation rate. Rothbard criticized the Laffer curve by saying that it should be a “straight line.” I understand Rothbard to mean that at some point the tax collected from deployed capital does not gradually decline with an increased tax rate, as the Laffer curve would suggest. Rather, the tax collected on capital gains immediately halts due to capital’s opportunity cost. Capital shifts to alternative passive investments based on the entrepreneur’s subjective value and imputed costs. The concept can be illustrated by the following formula:

[expected gain from capital] + [starting capital] − [taxes]

must be greater than (>)

[interest] + [principal] on an alternative passive investment

The opportunity cost of capital is therefore the risk-free interest rate obtainable on a passive income stream. No self-respecting entrepreneur sets out to lose capital when they can just put the money on term deposit.

An equity capital investment becomes less attractive as deposit rates rise. An equity capital investment also becomes less attractive if capital consumption, via taxation, occurs. To use a sporting analogy, capital may “sit on the sidelines” as entrepreneurs consider alternate investments. That sideline is often interest-bearing deposits. Where the expected net gain from capital only equals the alternative passive interest income stream, then said passive income stream is the preferred investment for two reasons:

1. There is a lower chance of capital losses on the risk-free rate.
2. There is a lower chance of capital consumption via taxation changes.

The first reason is straightforward. However, I see capital consumption as a more nuanced concept.

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