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Taxation of Labor Income and the Demand for Risky Assets

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  • Elmendorf, Douglas W
  • Kimball, Miles S

Abstract

This article analyzes the effect of labor income risk on the joint saving/portfolio-composition problem. Given decreasing absolute prudence, we find that even when labor income risk increases overall saving, it tends to lower investment in a risky asset. Applying the theory to public finance, we argue that realistic increases to marginal tax rates on labor can cause large enough reductions in after-tax labor income risk to cause significant increases in risky investment. Copyright 2000 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Suggested Citation

  • Elmendorf, Douglas W & Kimball, Miles S, 2000. "Taxation of Labor Income and the Demand for Risky Assets," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 41(3), pages 801-833, August.
    • Handle: RePEc:ier:iecrev:v:41:y:2000:i:3:p:801-33
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