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Taxation of labor income and the demand for risky assets

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  • Douglas W. Elmendorf
  • Miles S. Kimball

Abstract

It is well known that the implicit insurance provided by labor income taxes can reduce total saving. We show that this insurance can change the composition of saving as well, because the reduction in labor-income risk may affect the amount of financial risk that an individual chooses to bear. Given plausible restrictions on preferences, any change in taxes that reduces an individual's labor-income risk and does not make her worse off will lead her to invest more in risky assets. This effect can be quantitatively important for realistic changes in tax rates.

Suggested Citation

  • Douglas W. Elmendorf & Miles S. Kimball, 1996. "Taxation of labor income and the demand for risky assets," Finance and Economics Discussion Series 96-32, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:96-32
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    Keywords

    Saving and investment; Taxation;

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