Capital Income Taxation with Portfolio Choice

CERGE-EI Working Paper Series No. 668, 2020

52 Pages Posted: 17 Nov 2020

See all articles by Ivo Bakota

Ivo Bakota

Max Planck Institute for Social Law and Social Policy

Multiple version iconThere are 2 versions of this paper

Date Written: July 7, 2020

Abstract

This paper analyzes re-distributional and macroeconomic effects of differential taxation of financial assets with a different risk levels. The re-distributive effect stems from the fact that various households hold portfolios with a starkly different risk levels. In particular, poor households primarily save in safe assets, while rich households often invest a substantially higher share of their wealth in (risky) equity. At the same time, equity and safe assets are often taxed at different rates in many tax codes. This is primarily because investments in equity (which are relatively riskier) are taxed both as corporate and personal income, unlike debt, which is tax deductible for corporations. This paper firstly builds a simple theoretical two-period model which shows that the optimal tax wedge between risky and safe assets is increasing in the underlying wealth inequality. Furthermore, I build a quantitative model with a continuum of heterogeneous agents, parsimonious life-cycle, borrowing constraint, aggregate shocks and uninsurable idiosyncratic shocks, in which the government raises revenue by using linear taxes on risky and safe assets. Simulations of quantitative models shows that elimination of differential asset taxation leads to a welfare loss equivalent to a 0.3% permanent reduction in consumption. I find that the optimal tax wedge between taxes on equity and debt is higher than the one in the U.S. tax code.

Keywords: Portfolio Choice, Optimal Taxation, Redistribution

JEL Classification: E62, G11, G32, H21, H23

Suggested Citation

Bakota, Ivo, Capital Income Taxation with Portfolio Choice (July 7, 2020). CERGE-EI Working Paper Series No. 668, 2020, Available at SSRN: https://ssrn.com/abstract=3702255 or http://dx.doi.org/10.2139/ssrn.3702255

Ivo Bakota (Contact Author)

Max Planck Institute for Social Law and Social Policy ( email )

Amalienstrasse 33
Munich, 80799
Germany

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