Risk-Taking, Savings, and Taxation: A Re-Examination of Theory and Policy

Abstract

Considering broad-based taxes (consumption and income), this paper shows that both savings and risk-taking may be discouraged or left unchanged by proportional taxation with full loss-offsets. The analysis is carried out in a simple two-period model of asset and consumption allocation. These results are in sharp contrast to the standard result obtained in pure portfolio choice theory. The author further shows that a wealth tax may be construed as a prepayment version of the (cash flow) consumption tax. Compared with the latter, the wealth tax led to lower savings, but a riskier portfolio.