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Taxation and Risk Taking: A General Equilibrium Perspective

  • Louis Kaplow

Taxation and risk taking are examined in a general equilibrium model that incorporates uncertain government revenue in a nonrestrictive manner and allows the government to influence its revenue through portfolio investments as well as through tax policy. It is demonstrated that each of a wide range of taxes can be decomposed into some combination of a wage tax, an ex ante wealth tax, and a modification of the government's investment portfolio. For example, a tax on investment returns (from risky and riskless assets) is equivalent, with an adjustment in the government's portfolio, to a tax on the riskless component of investment returns or to an ex ante wealth tax -- both of which absorb no private risk and yield certain revenue. The concept of equivalence employed is strong: two regimes are equivalent if, for each state of nature, individuals' wealth and government revenue are the same under both regimes and total investment in each asset is the same. Implications for behavior (private and total risk taking) and welfare are immediate. Moreover, these results are independent of the government's objective function, the manner in which individual utility depends on government expenditures, and some of the restrictive assumptions found necessary in previous treatments of the problem.

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File URL: http://www.nber.org/papers/w3709.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3709.

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Date of creation: May 1991
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Publication status: published as National Tax Journal, Vol. 47 (1994), pp. 789-798.
Handle: RePEc:nbr:nberwo:3709
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  1. Jeremy I. Bulow & Lawrence H. Summers, 1982. "The Taxation of Risky Assets," NBER Working Papers 0897, National Bureau of Economic Research, Inc.
  2. Hines Jr., J.R., 1991. "Uncertain Tax Revenue And The Taxation Of Risky Assets," Papers 69, Princeton, Woodrow Wilson School - John M. Olin Program.
  3. J. E. Stiglitz, 1969. "The Effects of Income, Wealth, and Capital Gains Taxation on Risk-Taking," The Quarterly Journal of Economics, Oxford University Press, vol. 83(2), pages 263-283.
  4. J. Tobin, 1958. "Liquidity Preference as Behavior Towards Risk," Review of Economic Studies, Oxford University Press, vol. 25(2), pages 65-86.
  5. B. Dahlby, 1981. "Adverse selection and Pareto improvements through compulsory insurance," Public Choice, Springer, vol. 37(3), pages 547-558, January.
  6. Bohn, Henning, 1990. "Tax Smoothing with Financial Instruments," American Economic Review, American Economic Association, vol. 80(5), pages 1217-30, December.
  7. Agnar Sandmo, 1977. "Portfolio Theory, Asset Demand and Taxation: Comparative Statics with Many Assets," Review of Economic Studies, Oxford University Press, vol. 44(2), pages 369-379.
  8. Berkovec, James & Fullerton, Don, 1992. "A General Equilibrium Model of Housing, Taxes, and Portfolio Choice," Journal of Political Economy, University of Chicago Press, vol. 100(2), pages 390-429, April.
  9. Louis Kaplow, 1989. "Incentives and Government Relief for Risk," NBER Working Papers 3007, National Bureau of Economic Research, Inc.
  10. Gordon, Roger H & Wilson, John Douglas, 1989. "Measuring the Efficiency Cost of Taxing Risky Capital Income," American Economic Review, American Economic Association, vol. 79(3), pages 427-39, June.
  11. Feldstein, Martin S, 1969. "The Effects on Taxation on Risk Taking," Journal of Political Economy, University of Chicago Press, vol. 77(5), pages 755-64, Sept./Oct.
  12. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-71, October.
  13. Jack M. MINTZ, 1982. "«Neutral» Profit Taxation, Risk Taking and Optimal Profit Taxation," Discussion Papers (REL - Recherches Economiques de Louvain) 1982021, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  14. Alan J. Auerbach, 1981. "Evaluating the Taxation of Risky Assets," NBER Working Papers 0806, National Bureau of Economic Research, Inc.
  15. Roger H. Gordon, 1985. "Taxation of Corporate Capital Income: Tax Revenues Versus Tax Distortions," The Quarterly Journal of Economics, Oxford University Press, vol. 100(1), pages 1-27.
  16. Jack M. Mintz, 1981. "Some Additional Results on Investment, Risk Taking, and Full Loss Offset Corporate Taxation with Interest Deductibility," The Quarterly Journal of Economics, Oxford University Press, vol. 96(4), pages 631-642.
  17. Evsey D. Domar & Richard A. Musgrave, 1944. "Proportional Income Taxation and Risk-Taking," The Quarterly Journal of Economics, Oxford University Press, vol. 58(3), pages 388-422.
  18. E. Cary Brown, 1957. "Mr Kaldor on Taxation and Risk Bearing," Review of Economic Studies, Oxford University Press, vol. 25(1), pages 49-52.
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