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Welfare-improving Consumption Tax in the Presence of a Wage Tax under Idiosyncratic Returns from Investment and Incomplete Markets

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  • Hisahiro Naito

Abstract

In a standard multiperiod model, consumption tax and wage tax are equivalent. I show that when a capital market is incomplete - in the sense that the rates of return from risky investments are idiosyncratic and there is no insurance for such idiosyncratic risk - the introduction of a consumption tax in the presence of a wage tax improves welfare. This holds true even in the presence of optimal or nonoptimal capital income taxes. In the general-equilibrium model, the optimal level of the consumption tax is determined to balance the benefits of the risk-sharing effect and the asset accumulation effect against the costs of postponing government revenue to later periods.

Suggested Citation

  • Hisahiro Naito, 2018. "Welfare-improving Consumption Tax in the Presence of a Wage Tax under Idiosyncratic Returns from Investment and Incomplete Markets," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 74(3), pages 361-375, September.
    • Handle: RePEc:mhr:finarc:urn:sici:0015-2218(201809)73:3_361:wctitp_2.0.tx_2-k
    DOI: 10.1628/fa-2018-0010
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    More about this item

    Keywords

    incomplete capital market; risk sharing; consumption tax; optimal taxation;
    All these keywords.

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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