Pareto Improving Taxation in Incomplete Markets
AbstractWhen asset markets are incomplete there are almost always many Pareto improving policy interventions, provided there are multiple commodities and households. Remarkably, these interventions do not involve adding any new markets. Focusing on tax policy, I create a framework for proving the existence of Pareto improving taxes, for computing them, and for estimating the size of the Pareto improvement. It requires information about how taxes and prices affect aggregate, but not individual, demand. If taxes targeting current incomes are Pareto improving, then they must cause an equilibrium price adjustment, whose role is to redistribute wealth across states, creating insurance beyond the assets'. Conversely, I prove that if the price adjustment is sufficiently sensitive to risk aversions, then for almost all risk aversions and endowments, Pareto improving taxes exist. I show how to verify this sensitivity test with standard demand theory, which Turner (2003a) extends from complete to incomplete markets. I show that different policies generically admit Pareto improving taxes, by showing they all pass this same sensitivity test. These include (a) tax rates on purchases of assets, (b) lump-sum taxes on present income plus one flat tax rate on purchases of assets, (c) asset measurable tax rates on capital gains, (d) tax rates on net purchases of present commodities. I give a formula for the welfare impact of taxes, numerically identifying the Pareto improving taxes. The formula requires information about individual marginal utilities and net trades, and about the derivative of aggregate, not individual, demand with respect to prices and taxes. I estimate the rate of Pareto improvement by defining an agent's equilibrium insurance deficit. This deficit vanishes exactly when her commodity demand is as though markets were complete. The rate is quadratic in the insurance deficits, and affine in the level of trade and in the proximity to price crashes
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Brown University, Department of Economics in its series Working Papers with number 2006-03.
Date of creation: 2006
Date of revision:
Contact details of provider:
Postal: Department of Economics, Brown University, Providence, RI 02912
Other versions of this item:
- Sergio Turner, 2004. "Pareto Improving Taxation in Incomplete Markets," Econometric Society 2004 North American Summer Meetings 614, Econometric Society.
- Sergio Turner, 2004. "Pareto Improving Taxation in Incomplete Markets," Econometric Society 2004 Latin American Meetings 310, Econometric Society.
- D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
- D62 - Microeconomics - - Welfare Economics - - - Externalities
- G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-04-22 (All new papers)
- NEP-PBE-2006-04-22 (Public Economics)
- NEP-PUB-2006-04-22 (Public Finance)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Duffie, Darrell & Shafer, Wayne, 1985. "Equilibrium in incomplete markets: I : A basic model of generic existence," Journal of Mathematical Economics, Elsevier, vol. 14(3), pages 285-300, June.
- DEBREU, Gérard, .
CORE Discussion Papers RP
-132, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- Bisin, A. & Geanakoplos, J.D. & Gottardi, P. & Minelli, E. & Polemarchakis, H., 2011.
"Markets and contracts,"
Journal of Mathematical Economics,
Elsevier, vol. 47(3), pages 279-288.
- Alberto Bisin & John Geanakoplos & Piero Gottardi & Enrico Minelli & Heracles Polemarchakis, 2009. "Markets and Contracts," Working Papers 0915, University of Brescia, Department of Economics.
- Alberto Bisin & John Geanakoplos & Piero Gottardi & Enrico Minelli & Herakles Polemarchakis, 2010. "Markets and contracts," Economics Working Papers ECO2010/29, European University Institute.
- Magill, Michael & Shafer, Wayne, 1991. "Incomplete markets," Handbook of Mathematical Economics, in: W. Hildenbrand & H. Sonnenschein (ed.), Handbook of Mathematical Economics, edition 1, volume 4, chapter 30, pages 1523-1614 Elsevier.
- Michael Mandler, 2004. "Policy effectiveness," Econometric Society 2004 North American Summer Meetings 480, Econometric Society.
- CITANNA, Alessandro & POLEMARCHAKIS, Herakles M. & TIRELLI, Mario, 2001.
"The taxation of trades in assets,"
CORE Discussion Papers
2001017, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- David Cass & Alessandro Citanna, 1998. "Pareto improving financial innovation in incomplete markets," Economic Theory, Springer, vol. 11(3), pages 467-494.
- Atsushi Kajii & Antonio Villanacci & Alessandro Citanna, 1998. "Constrained suboptimality in incomplete markets: a general approach and two applications," Economic Theory, Springer, vol. 11(3), pages 495-521.
- Debreu, Gerard, 1976. "Smooth Preferences: A Corrigendum," Econometrica, Econometric Society, vol. 44(4), pages 831-32, July.
- Stiglitz, Joseph E, 1982. "The Inefficiency of the Stock Market Equilibrium," Review of Economic Studies, Wiley Blackwell, vol. 49(2), pages 241-61, April.
- Herakles Polemarchakis, 2001. "The taxation of trades in assests," Working Papers 2001-21, Brown University, Department of Economics.
- repec:fth:louvco:0117 is not listed on IDEAS
- Elul Ronel, 1995. "Welfare Effects of Financial Innovation in Incomplete Markets Economies with Several Consumption Goods," Journal of Economic Theory, Elsevier, vol. 65(1), pages 43-78, February.
- Geanakoplos, J D & Polemarchakis, H M, 1980. "On the Disaggregation of Excess Demand Functions," Econometrica, Econometric Society, vol. 48(2), pages 315-31, March.
- Fiorini, Luciana C., 2008. "Overlapping generations and idiosyncratic risk: Can prices reveal the best policy?," Journal of Mathematical Economics, Elsevier, vol. 44(12), pages 1312-1320, December.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Brown Economics Webmaster).
If references are entirely missing, you can add them using this form.