Fiscal Policies and Asset Prices

Thien Nguyen, Lukas Schmid, Howard Kung and Mariano Croce
Additional contact information
Thien Nguyen: Wharton, UPenn
Lukas Schmid: Duke University
Howard Kung: Duke University
Mariano Croce: University of North Carolina at Chapel H

No 565, 2012 Meeting Papers from Society for Economic Dynamics

Abstract: The surge in public debt triggered by the financial crisis has raised uncertainty about future tax pressure and economic activity. We contribute to the current fiscal debate by examining the asset pricing effects of fiscal policies in a production-based general equilibrium model in which taxation affects corporate decisions by: i) distorting profits and investment; ii) reducing the cost of debt through a tax shield; and iii) weakening productivity growth. In settings with recursive preferences, these three tax-based channels generate sizable risk premia making tax uncertainty a first order concern. We document further that corporate tax smoothing significantly affects the cost of equity by altering the intertemporal distribution of consumption. While common tax smoothing increases the annual cost of equity by almost 1%, public financing policies aimed at stabilizing capital accumulation reduce both long-run consumption risk and the cost of capital, producing relevant welfare benefits.

Date: 2012
New Economics Papers: this item is included in nep-dge and nep-pbe
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Citations: View citations in EconPapers (70)

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