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Investment Risk, Pareto Distribution, and the Effects of Tax

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  • NIREI Makoto

Abstract

This paper investigates the effects of taxation on the distributions of income and wealth and on the welfare of heterogeneous households. I first demonstrate that the tails of income and wealth distributions converge to a Pareto distribution in a Bewley model in which households bear idiosyncratic investment shocks. This result extends the previous analysis in Nirei (2009). Thereafter, a non-distortionary tax and flat-rate taxes on capital income and consumption are introduced, and their impacts on aggregate wealth, the inequality index, households' welfare, and transition paths are quantitatively investigated. When the tax rate is set to generate the same GDP-government expenditure ratio, the model with capital tax generates smaller aggregate wealth and a smaller inequality index than the case with consumption tax or non-distortionary tax.

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Paper provided by Research Institute of Economy, Trade and Industry (RIETI) in its series Discussion papers with number 11015.

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Length: 36 pages
Date of creation: Mar 2011
Date of revision:
Handle: RePEc:eti:dpaper:11015

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  1. Francisco Covas, 2005. "Uninsured Idiosyncratic Production Risk with Borrowing Constraints," Working Papers 05-26, Bank of Canada.
  2. Fatih Guvenen & Burhanettin Kuruscu & Serdar Ozkan, 2013. "Taxation of human capital and wage inequality: a cross-country analysis," Finance and Economics Discussion Series 2013-20, Board of Governors of the Federal Reserve System (U.S.).
  3. Xavier Gabaix, 1999. "Zipf'S Law For Cities: An Explanation," The Quarterly Journal of Economics, MIT Press, vol. 114(3), pages 739-767, August.
  4. Sagiri Kitao, 2008. "Entrepreneurship, taxation and capital investment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(1), pages 44-69, January.
  5. Huggett, Mark, 1996. "Wealth distribution in life-cycle economies," Journal of Monetary Economics, Elsevier, vol. 38(3), pages 469-494, December.
  6. Marco Cagetti & Mariacristina De Nardi, 2004. "Taxation, entrepreneurship and wealth," Working Papers 632, Federal Reserve Bank of Minneapolis.
  7. Ana Castaneda & Javier Diaz-Gimenez & Jose-Victor Rios-Rull, 2003. "Accounting for the U.S. Earnings and Wealth Inequality," Journal of Political Economy, University of Chicago Press, vol. 111(4), pages 818-857, August.
  8. Nirei, Makoto, 2009. "Pareto Distributions in Economic Growth Models," IIR Working Paper 09-05, Institute of Innovation Research, Hitotsubashi University.
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