Risk-Taking and Optimal Taxation with Nontradable Human Capital

December 1, 1992

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Format: Chicago

Zuliu Hu. Risk-Taking and Optimal Taxation with Nontradable Human Capital, (USA: International Monetary Fund, 1992) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

What are the effects of taxation on individual/entrepreneurs’ risk-taking behavior? This paper re-examines this old question in a continuous time life-cycle model. We demonstrate that the stream of uncertain income from human capital has systematic effects on demand for the risky physical capital asset. If labor supply is inelastic and real wages are known with certainty, then a labor income tax will reduce holdings of the risky physical asset. However, if there are random fluctuations in labor income, then the effect depends on the nature of interaction between wage risk and investment income risk. A labor income tax may actually raise demand for the risky capital asset if human capital risk and physical capital risk are positively correlated. The idiosyncratic risk and nontradability of human capital also have implications for optimal taxation. When the insurance and disincentive effects are jointly taken into account, a Pareto efficient tax structure implies a strictly positive tax rate.

Subject: Consumption, Human capital, Labor, Labor supply, Personal income

Keywords: Utility function, WP

Publication Details

Pages:

22
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 1992/105
Stock No:

WPIEA1051992
ISBN:

9781451947427
ISSN:

1018-5941

Notes

Also published in Staff Papers, Vol. 40, No. 3, September 1993.

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