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Equilibrium Security Prices with Capital Income Taxes and an Exogenous Interest Rate

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  • Marc Steffen Rapp
  • Bernhard Schwetzler

Abstract

We are interested in the effect of capital income taxes upon security prices when investors face locally segmented stock markets and a global bond market. Therefore, we analyze an equilibrium model of an economy with binomial uncertainty, an exogenous risk-free interest rate, and a representative stand-in household. In this setting, the pricing effect for domestic securities is shown to be a function of three variables: the covariance between pretax payoffs of securities and the aggregated market portfolio, the exogenous pretax interest rate, and the effect of taxation (and redistribution) on the aggregate welfare of the stand-in household. We find that taxation of capital income is nondistorting if tax proceeds are immediately redistributed within the cohort of capital market participants. If, however, taxation represents a policy tool to transfer wealth from capital market participants to non-market-participants, then the level of the statutory tax rate is reflected in equilibrium security prices, and taxation affects households portfolio decisions, which in turn may affect investment decisions of firms.

Suggested Citation

  • Marc Steffen Rapp & Bernhard Schwetzler, 2008. "Equilibrium Security Prices with Capital Income Taxes and an Exogenous Interest Rate," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 64(3), pages 334-351, September.
    • Handle: RePEc:mhr:finarc:urn:sici:0015-2218(200809)64:3_334:espwci_2.0.tx_2-
    DOI: 10.1628/001522108X374160
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    Cited by:

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    3. Sven Arnold & Alexander Lahmann & Bernhard Schwetzler, 2018. "Discontinuous financing based on market values and the value of tax shields," Business Research, Springer;German Academic Association for Business Research, vol. 11(1), pages 149-171, February.

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    More about this item

    Keywords

    equilibrium security prices; capital income tax; equity premium;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies

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