A unified framework for optimal taxation with undiversifiable risk

Catarina Reis () and Vasia Panousi
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Vasia Panousi: Board of Governors of the Federal Reserv

No 951, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: This paper considers a model of linear capital taxation for an economy where capital and labor income are subject to idiosyncratic uninsurable risk. To keep the model tractable, we assume that investment decisions are made before uncertainty is realized, so that the realization of the capital income shock only affects current consumption. In this setting, we find that the optimal capital tax is positive in the long run if there is only capital income risk. The reason for this is that the capital tax provides insurance against capital income risk. On the other hand, if there is only labor income risk the optimal capital tax is zero. The sign of the optimal tax is ambiguous if both types of risk are present and depends on the correlation between the two shocks.

Date: 2016
New Economics Papers: this item is included in nep-dge and nep-pbe
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