On the Optimality of Differential Asset Taxation

59 Pages Posted: 30 Aug 2019 Last revised: 2 Sep 2022

See all articles by Thomas Phelan

Thomas Phelan

Federal Reserve Banks - Federal Reserve Bank of Cleveland

Date Written: September 1, 2022


How should a government balance risk-sharing and redistributive concerns with the need to provide incentives for investment? Should they tax firm profits or individual savings, or simply levy lump-sum transfers? I address these questions in an environment with entrepreneurs and workers in which output is subject to privately observed shocks and firm owners can both misreport profits and abscond with a fraction of assets. When frictions in financial markets restrict private risk-sharing, the stationary efficient allocation may be implemented in a competitive equilibrium with collateral constraints using (occupation-specific) linear taxes on savings and profits and lump-sum transfers to newborns. Further, the two taxes serve distinct roles and in general differ from one another. The savings tax affects consumption smoothing and may be positive or negative depending on the strength of general equilibrium effects, while the profits tax shares risk between the government and entrepreneurs, is unambiguously positive, and depends solely on the degree of frictions in financial markets.

Keywords: optimal taxation, moral hazard, optimal contracting

JEL Classification: D61, D63, E62

Suggested Citation

Phelan, Thomas, On the Optimality of Differential Asset Taxation (September 1, 2022). FRB of Cleveland Working Paper No. 19-17R, Available at SSRN: https://ssrn.com/abstract=3445140 or http://dx.doi.org/10.2139/ssrn.3445140

Thomas Phelan (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

HOME PAGE: http://https://www.clevelandfed.org/our-research/economists/tom-phelan.aspx

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