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

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  • Hisahiro Naito

Abstract

In a standard multi-period 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 consumption tax in the presence of wage tax improves welfare. This holds true even in the presence of optimal or non-optimal capital income taxes. In the general equilibrium model, the optimal level of consumption tax is determined to balance the benefits of the risk-sharing effect and asset accumulation effect and the costs of postponing government revenue to later periods.

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  • Hisahiro Naito, 2018. "Welfare-improving Consumption Tax in the Presence of Wage Tax under Idiosyncratic Returns from Investment and Incomplete Markets," Tsukuba Economics Working Papers 2018-002, Economics, Graduate School of Humanities and Social Sciences, University of Tsukuba.
  • Handle: RePEc:tsu:tewpjp:2018-002
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    1. Peter A. Diamond, 2005. "Taxation, Incomplete Markets, and Social Security," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262541823, May.
    2. Brian K. Bucks & Arthur B. Kennickell & Traci L. Mach & Kevin B. Moore, 2009. "Changes in U.S. family finances from 2004 to 2007: evidence from the Survey of Consumer Finances," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.).
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