Constrained Inefficiency and Optimal Taxation with Uninsurable Risks
AbstractShould capital and labor be taxed, and if so how when individuals' labor and capital income are subject to uninsurable idiosyncratic risks? In a two period general equilibrium model with production, we first show that reducing investment is welfare improving if households are homogeneous enough ex ante. On the other hand, when the degree of heterogeneity is sufficientlyhigh a welfare improvement is achieved by increasing investment, even if the investment level is already higher than at the e¢ cient allocation obtained when full insurance markets were available. Consequently, the optimal capital tax rate might be negative. We derive a decomposition formula of the e¤ects of the tax which allow us to determine how the sign of optimal tax on capital and labor depends both on the nature of the shocks and the degree of heterogeneity among consumers as well as on the way in which the tax revenue is allocated.
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Bibliographic InfoPaper provided by European University Institute in its series Economics Working Papers with number ECO2010/02.
Date of creation: 2010
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- Piero Gottardi & Atsushi Kajii & Tomoyuki Nakajima, 2010. "Constrained Inefficiency and Optimal Taxation with Uninsurable Risks," KIER Working Papers 694, Kyoto University, Institute of Economic Research.
- NEP-ALL-2010-04-17 (All new papers)
- NEP-DGE-2010-04-17 (Dynamic General Equilibrium)
- NEP-IAS-2010-04-17 (Insurance Economics)
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