Taxation, Transfer Income and Stock Market Participation

Abstract

We study a redistributive tax system that taxes income and redistributes tax revenues in such a way that relatively rich agents are net contributors to relatively poor agents. The closed-form solution of our model allows two main conclusions: (i) Despite ongoing transfers, wealth levels are not harmonized because poorer agents mainly use their transfer income to finance present consumption. (ii) Since the evolution of the economy determines both the level of tax revenues and the evolution of the stock market, transfer income is subject to stock market risk. Hence, poorer agents optimally reduce their equity shares. This can happen to an extent that they optimally no longer participate in the stock market.

Keywords: redistributive taxation, portfolio choice, asset pricing, stock market participation

JEL Classification: G11, E21, H24