Asset Returns, Portfolio Choice, and Proportional Wealth Taxation

We analyse the effect of a proportional wealth tax on asset returns, portfolio choice, and asset pricing. The tax is levied annually on the market value of all holdings at a uniform rate. We show that such a tax is economically equivalent to the government acquiring a proportional stake in the investor's portfolio each period, a form of risk sharing in which expected wealth and risk are reduced by the same factor, while the return per share is unaffected. This multiplicative separability drives four main results: (i) the coefficient of variation of wealth is invariant to the tax rate; (ii) optimal portfolio weights are independent of the tax rate; (iii) the wealth tax is orthogonal to portfolio choice, inducing a homothetic contraction of the opportunity set that preserves the Sharpe ratio of every portfolio; (iv) taxed and untaxed investors price assets identically. Results are derived under geometric Brownian motion and generalised to the location-scale family. A Modigliani-Miller analysis confirms pricing neutrality and identifies an inconsistency in the literature regarding the discount rate for after-tax cash flows. Under CAPM with CRRA preferences, after-tax betas equal pre-tax betas and the security market line contracts by the tax factor; general-equilibrium prices are unchanged. This resolves an error in Fama (2021). The neutrality results depend on three conditions commonly violated in practice: universal taxation at market value, frictionless markets, and dividend consumption. We formalise three channels through which relaxing these conditions breaks neutrality: book-value taxation, liquidity frictions, and dividend extraction, and show they have opposing effects on asset prices.