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Optimal Capital Taxation with Idiosyncratic Investment Risk

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  • Catarina Reis

    (Universidade Catolica Portuguesa)

  • Vasia Panousi

    (Federal Reserve Board)

Abstract

We examine the optimal taxation of capital in a Ramsey setting of a general-equilibrium heterogeneous-agent economy with uninsurable idiosyncratic investment or capital-income risk. We fully characterize the optimal tax in the case where there is no safe income in the economy. When the interest rate is allowed to adjust to changes in the capital tax, the optimal capital tax is always constant, even off steady state, and is positive when the variance of risk is higher than the mean return to the risky asset. When the interest rate is exogenously fixed, the optimal capital tax is zero. Therefore, general-equilibrium considerations are crucial for the dynamic effects of capital taxation when investment is risky.

Suggested Citation

  • Catarina Reis & Vasia Panousi, 2012. "Optimal Capital Taxation with Idiosyncratic Investment Risk," 2012 Meeting Papers 732, Society for Economic Dynamics.
    • Handle: RePEc:red:sed012:732
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    References listed on IDEAS

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    Cited by:

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    2. Nicholas Bloom & Max Floetotto & Nir Jaimovich & Itay Saporta†Eksten & Stephen J. Terry, 2018. "Really Uncertain Business Cycles," Econometrica, Econometric Society, vol. 86(3), pages 1031-1065, May.
    3. Krueger, Dirk & Ludwig, Alexander & Villalvazo, Sergio, 2021. "Optimal taxes on capital in the OLG model with uninsurable idiosyncratic income risk," Journal of Public Economics, Elsevier, vol. 201(C).
    4. Shenghao Zhu, 2019. "A Becker–Tomes model with investment risk," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 67(4), pages 951-981, June.
    5. Ivo Bakota, 2020. "Capital Income Taxation with Portfolio Choice," CERGE-EI Working Papers wp668, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    6. Jason M. DeBacker & Bradley T. Heim & Vasia Panousi & Shanthi Ramnath & Ivan Vidangos, 2012. "The properties of income risk in privately held businesses," Finance and Economics Discussion Series 2012-69, Board of Governors of the Federal Reserve System (U.S.).
    7. Corina Boar & Matthew Knowles, 2020. "Entrepreneurship, Agency Frictions and Redistributive Capital Taxation," Discussion Paper Series, School of Economics and Finance 202004, School of Economics and Finance, University of St Andrews.
    8. Sebastian Dyrda & Marcelo Pedroni, 2015. "Optimal Fiscal Policy in a Model with Uninsurable Idiosyncratic Shocks," Working Papers tecipa-549, University of Toronto, Department of Economics.
    9. Hui Guo & Buhui Qiu, 2023. "Conditional Equity Premium and Aggregate Corporate Investment," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 55(1), pages 251-295, February.
    10. Benjamin Pugsley & Sebastian Dyrda, 2017. "Taxes, Regulations of Businesses and Evolution of Income Inequality in the US," 2017 Meeting Papers 1463, Society for Economic Dynamics.

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