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Speaker:
Ivo Bakota (Munich Center for the Economics of Aging)

Capital Income Taxation with Portfolio Choice

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

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