Tax Uncertainty, Risk Sharing, and Asset Prices

Abstract

We develop a general equilibrium overlapping generations model to analyze the impact of tax uncertainty on asset prices. While redistributive taxation alone cannot generate risk premiums in complete markets with perfect risk sharing, we show that when combined with imperfect inter-generational risk sharing and recursive preferences, uncertain tax policies produce significant equity premiums. This result shows that tax uncertainty can create endogenous aggregate risk, beyond their direct effect on individual investment decisions. Our model with stochastic taxation successfully captures key stylized facts regarding the equity premium, interest rates, stock return volatility, and the price-dividend ratio.

Keywords: Tax Policy, Redistribution, Risk Sharing, Equity Premium, Aggregate Risk

JEL Classification: G10, G12