Optimal Capital Taxation with Idiosyncratic Investment Risk

24 Pages Posted: 1 Jan 2013

See all articles by Vasia Panousi

Vasia Panousi

University of Montreal, Department of Economics

Catarina Reis

Universidade Católica Portuguesa

Multiple version iconThere are 2 versions of this paper

Date Written: September 17, 2012

Abstract

We examine the optimal taxation of capital in a Ramsey setting of a general-equilibrium heterogeneous-agent economy with uninsurable idiosyncratic investment or capital-income risk. We prove that the ex ante optimal tax, evaluated at steady state, maximizes human wealth, namely the present discounted value of agents' income from sources that are not subject to capital risk. Furthermore, when the amount of idiosyncratic risk in the economy is higher than a minimum lower bound, the optimal tax is positive and it is precisely the tax that maximizes the economy-wide aggregates, such as the capital stock and output. By contrast, when the amount of risk is exogenously very low, the social planner finds it optimal to increase social risk taking by subsidizing investment in capital.

Keywords: optimal capital taxation, idiosyncratic investment risk, general equilibrium, heterogeneous agents

JEL Classification: E13, E22, E62

Suggested Citation

Panousi, Vasia and Reis, Catarina, Optimal Capital Taxation with Idiosyncratic Investment Risk (September 17, 2012). FEDS Working Paper No. 2012-70, Available at SSRN: https://ssrn.com/abstract=2195200 or http://dx.doi.org/10.2139/ssrn.2195200

Vasia Panousi (Contact Author)

University of Montreal, Department of Economics ( email )

C.P. 6128 succursale Centre-ville
Montreal, Quebec H3C 3J7
Canada

HOME PAGE: http://https://sites.google.com/site/panousi/

Catarina Reis

Universidade Católica Portuguesa ( email )

Portugal

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