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On the Optimality of Differential Asset Taxation

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Abstract

How should a government balance risk-sharing and redistributive concerns with the need to provide incentives for investment? Should they tax firm profits or individual savings, or simply levy lump-sum transfers? I address these questions in an environment with entrepreneurs and workers in which output is subject to privately observed shocks and firm owners can both misreport profits and abscond with a fraction of assets. When frictions in financial markets restrict private risk-sharing, the stationary efficient allocation may be implemented in a competitive equilibrium with collateral constraints using (occupation-specific) linear taxes on savings and profits and lump-sum transfers to newborns. Further, the two taxes serve distinct roles and in general differ from one another. The savings tax affects consumption smoothing and may be positive or negative depending on the strength of general equilibrium effects, while the profits tax shares risk between the government and entrepreneurs, is unambiguously positive, and depends solely on the degree of frictions in financial markets.

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  • Tom Phelan, 2019. "On the Optimality of Differential Asset Taxation," Working Papers 19-17R, Federal Reserve Bank of Cleveland, revised 01 Sep 2022.
    • Handle: RePEc:fip:fedcwq:191700
    DOI: 10.26509/frbc-wp-201917r
    Note: Replication materials may be found at https://github.com/tphelanECON/diff_cap_tax
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    References listed on IDEAS

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    1. Prescott, Edward C & Townsend, Robert M, 1984. "Pareto Optima and Competitive Equilibria with Adverse Selection and Moral Hazard," Econometrica, Econometric Society, vol. 52(1), pages 21-45, January.
    2. Thomas Phelan, 2019. "Efficient wealth inequality and differential asset taxation with dynamic agency," 2019 Meeting Papers 1350, Society for Economic Dynamics.
    3. Roger H. Gordon & Joel Slemrod, 1988. "Do We Collect Any Revenue from Taxing Capital Income?," NBER Chapters, in: Tax Policy and the Economy: Volume 2, pages 89-130, National Bureau of Economic Research, Inc.
    4. J. A. Mirrlees, 1971. "An Exploration in the Theory of Optimum Income Taxation," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 38(2), pages 175-208.
    5. Catarina Reis & Vasia Panousi, 2016. "A unified framework for optimal taxation with undiversifiable risk," 2016 Meeting Papers 951, Society for Economic Dynamics.
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    More about this item

    Keywords

    Optimal taxation; moral hazard; optimal contracting;
    All these keywords.

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • D63 - Microeconomics - - Welfare Economics - - - Equity, Justice, Inequality, and Other Normative Criteria and Measurement
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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