Optimal Taxation of Normal and Excess Returns to Risky Assets

Tinbergen Institute Discussion Paper 2021-025/VI

50 Pages Posted: 22 Mar 2021

See all articles by Robin Boadway

Robin Boadway

Queen's University; CESifo (Center for Economic Studies and Ifo Institute); Centre Interuniversitaire sur le Risque, les Politiques Economiques et l'Emploi (CIRPEE)

Kevin Spiritus

KU Leuven; Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)

Date Written: March 15, 2021

Abstract

We study the optimal taxation of risk-free and excess capital income with heterogeneous rates of return, alongside an optimal nonlinear earnings tax. Households can hold three assets: one risk-free, one risky but diversifiable, and one a private investment with idiosyncratic risk whose expected return differs among households. Contrary to expectations, the optimal tax on excess returns to risky assets is ineffective for redistribution, because its effects are annulled by a Domar-Musgrave effect. It assumes only an insurance role, and is positive. The optimal tax on risk-free returns does fulfill a redistributive role, insofar the risk-free returns reveal information about the investors' types beyond what is revealed by the earnings tax base. The optimal nonlinear earnings tax takes the standard Mirrleesian form amended to take account of the stochasticity of capital income tax revenue.

Keywords: optimal capital taxation, Rate-of-Return Allowance, risk, excess returns

JEL Classification: H21, H23, H24

Suggested Citation

Boadway, Robin and Spiritus, Kevin and Spiritus, Kevin, Optimal Taxation of Normal and Excess Returns to Risky Assets (March 15, 2021). Tinbergen Institute Discussion Paper 2021-025/VI, Available at SSRN: https://ssrn.com/abstract=3807468 or http://dx.doi.org/10.2139/ssrn.3807468

Robin Boadway (Contact Author)

Queen's University ( email )

99 University Avenue
Kingston K7L 3N6, Ontario
Canada
613-533-2266 (Phone)
613-533-6668 (Fax)

HOME PAGE: http://qed.econ.queensu.ca/pub/faculty/boadway/

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre Interuniversitaire sur le Risque, les Politiques Economiques et l'Emploi (CIRPEE)

Ste-Foy, Quebec G1K 7P4
Canada

Kevin Spiritus

KU Leuven ( email )

Oude Markt 13
Leuven, Vlaams-Brabant 3000
Belgium

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

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