Equilibrium Security Prices with Capital Income Taxes and an Exogenous Interest Rate

Marc Steffen Rapp and Bernhard Schwetzler

FinanzArchiv: Public Finance Analysis, 2008, vol. 64, issue 3, 334-351

Abstract: We are interested in the effect of capital income taxes upon security prices when investors face locally segmented stock markets and a global bond market. Therefore, we analyze an equilibrium model of an economy with binomial uncertainty, an exogenous risk-free interest rate, and a representative stand-in household. In this setting, the pricing effect for domestic securities is shown to be a function of three variables: the covariance between pretax payoffs of securities and the aggregated market portfolio, the exogenous pretax interest rate, and the effect of taxation (and redistribution) on the aggregate welfare of the stand-in household. We find that taxation of capital income is nondistorting if tax proceeds are immediately redistributed within the cohort of capital market participants. If, however, taxation represents a policy tool to transfer wealth from capital market participants to non-market-participants, then the level of the statutory tax rate is reflected in equilibrium security prices, and taxation affects households portfolio decisions, which in turn may affect investment decisions of firms.

Keywords: equilibrium security prices; capital income tax; equity premium (search for similar items in EconPapers)
JEL-codes: G12 G18 H24 (search for similar items in EconPapers)
Date: 2008
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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DOI: 10.1628/001522108X374160

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