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

Hisahiro Naito

Tsukuba Economics Working Papers from Faculty of Humanities and Social Sciences, University of Tsukuba

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.

Date: 2018-02
New Economics Papers: this item is included in nep-dge, nep-pbe and nep-pub
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