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

Hisahiro Naito

FinanzArchiv: Public Finance Analysis, 2018, vol. 74, issue 3, 361-375

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

Keywords: incomplete capital market; risk sharing; consumption tax; optimal taxation (search for similar items in EconPapers)
JEL-codes: H21 (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1628/fa-2018-0010

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