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Constrained Inefficiency and Optimal Taxation with Uninsurable Risks

  • Piero Gottardi

    (European University Institute and Universita Ca' Foscari, Venice)

  • Atsushi Kajii

    ()

    (Kyoto University and Singapore Management University)

  • Tomoyuki Nakajima

    ()

    (Kyoto University and CIGS)

When individuals' labor and capital income are subject to uninsurable idiosyncratic risks, should capital and labor be taxed, and if so how? In a two period general equilibrium model with production, we derive a decomposition formula of the welfare effects of these taxes into insurance and distribution effects. This allows us to determine how the sign of the optimal taxes on capital and labor depend on the nature of the shocks, the degree of heterogeneity among consumers' income as well as on the way in which the tax revenue is used to provide lump sum transfers to consumers. When shocks affect primarily labor income and heterogeneity is small, the optimal tax on capital is positive. However in other cases a negative tax on capital is welfare improving.

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File URL: http://www.kier.kyoto-u.ac.jp/DP/DP694.pdf
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Paper provided by Kyoto University, Institute of Economic Research in its series KIER Working Papers with number 694.

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Length: 28pages
Date of creation: Aug 2014
Date of revision:
Handle: RePEc:kyo:wpaper:694
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  1. repec:hal:journl:halshs-00196183 is not listed on IDEAS
  2. Kenneth L. Judd, 1982. "Redistributive Taxation in a Simple Perfect Foresight Model," Discussion Papers 572, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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  8. Atsushi Kajii & Antonio Villanacci & Alessandro Citanna, 1998. "Constrained suboptimality in incomplete markets: a general approach and two applications," Economic Theory, Springer, vol. 11(3), pages 495-521.
  9. Aiyagari, S Rao, 1995. "Optimal Capital Income Taxation with Incomplete Markets, Borrowing Constraints, and Constant Discounting," Journal of Political Economy, University of Chicago Press, vol. 103(6), pages 1158-75, December.
  10. Stiglitz, Joseph E, 1982. "The Inefficiency of the Stock Market Equilibrium," Review of Economic Studies, Wiley Blackwell, vol. 49(2), pages 241-61, April.
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