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Asset Prices in the Presence of a Tax Authority

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  • Marc Rapp

    (Leipzig Graduate School of Management (HHL))

  • Bernhard Schwetzler

    (Leipzig Graduate School of Management (HHL))

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    Abstract

    This paper examines the equilibrium effect of a shift in the capital income tax rate upon state prices, risk-neutral probabilities, and corresponding security prices in a single-period binomial model economy with an exogenous risk-free rate. The policy design under consideration consists of a simple linear tax code that applies the economic rent as a tax base. It is shown that if tax proceeds are transferred to outsiders, a shift in the tax rate affects state prices, risk-neutral probabilities as well as equilibrium security prices. Thereby, the effect for the equilibrium price of a security is sensitive with respect to the correlation between its own payoff and the payoff of the market portfolio. If in contrast tax proceeds are redistributed within the cohort of market participants, risk-neutral probabilities, and security prices are unaffected by a change in the tax rate, although state prices are sensitive with respect to the tax rate.

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    Bibliographic Info

    Paper provided by Berkeley Electronic Press in its series German Working Papers in Law and Economics with number 2006-1-1167.

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    Handle: RePEc:bep:dewple:2006-1-1167

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    Keywords: Equilibrium security prices; capital income tax; risk-neutral probability measure;

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    1. Harrison Hong & Jeffrey D. Kubik & Jeremy C. Stein, 2005. "The Only Game in Town: Stock-Price Consequences of Local Bias," NBER Working Papers 11488, National Bureau of Economic Research, Inc.
    2. Mankiw, N.G. & Zeldes, S.P., 1990. "The Consumption Of Stockholders And Non-Stockholders," Weiss Center Working Papers 23-90, Wharton School - Weiss Center for International Financial Research.
    3. Litzenberger, Robert H. & Ramaswamy, Krishna, 1979. "The effect of personal taxes and dividends on capital asset prices : Theory and empirical evidence," Journal of Financial Economics, Elsevier, vol. 7(2), pages 163-195, June.
    4. Joseph E. Stiglitz, 1968. "The Effects of Income, Wealth, and Capital Gains Taxation on Risk Taking," Cowles Foundation Discussion Papers 248, Cowles Foundation for Research in Economics, Yale University.
    5. Bulow, Jeremy I & Summers, Lawrence H, 1984. "The Taxation of Risky Assets," Journal of Political Economy, University of Chicago Press, vol. 92(1), pages 20-39, February.
    6. Brennan, M. J. & Kraus, Alan, 1978. "Necessary Conditions for Aggregation in Securities Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 13(03), pages 407-418, September.
    7. Isabelle Joumard, 2001. "Tax Systems in European Union Countries," OECD Economics Department Working Papers 301, OECD Publishing.
    8. Ellen R. McGrattan & Edward C. Prescott, 2005. "Taxes, Regulations, and the Value of U.S. and U.K. Corporations," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 767-796.
    9. Paul A. Samuelson, 1964. "Tax Deductibility of Economic Depreciation to Insure Invariant Valuations," Journal of Political Economy, University of Chicago Press, vol. 72, pages 604.
    10. Karen K. Lewis, 1999. "Trying to Explain Home Bias in Equities and Consumption," Journal of Economic Literature, American Economic Association, vol. 37(2), pages 571-608, June.
    11. Margit Schratzenstaller, 2003. "Dualisierung von Einkommensteuersystemen: Stand und Perspektiven im internationalen Vergleich," Vierteljahrshefte zur Wirtschaftsforschung / Quarterly Journal of Economic Research, DIW Berlin, German Institute for Economic Research, vol. 72(4), pages 535-550.
    12. James M. Poterba, 2001. "Taxation, Risk-Taking, and Household Portfolio Behavior," NBER Working Papers 8340, National Bureau of Economic Research, Inc.
    13. Gordon, Roger H, 1985. "Taxation of Corporate Capital Income: Tax Revenues versus Tax Distortions," The Quarterly Journal of Economics, MIT Press, vol. 100(1), pages 1-27, February.
    14. Sandmo, Agnar, 1989. "Differential taxation and the encouragement of risk-taking," Economics Letters, Elsevier, vol. 31(1), pages 55-59.
    15. Litzenberger, Robert H & Ramaswamy, Krishna, 1980. " Dividends, Short Selling Restrictions, Tax-Induced Investor Clienteles and Market Equilibrium," Journal of Finance, American Finance Association, vol. 35(2), pages 469-82, May.
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    Cited by:
    1. Schosser, Josef, 2008. "Bewertung ohne "Kapitalkosten": Ein arbitragetheoretischer Ansatz zu Unternehmenswert, Kapitalstruktur und persönlicher Besteuerung," Passauer Diskussionspapiere, Betriebswirtschaftliche Reihe 13, University of Passau, Faculty of Business and Economics.

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