DP10899 Income Inequality and Asset Prices under Redistributive Taxation

Author(s): Luboš Pástor, Pietro Veronesi
Publication Date: October 2015
Keyword(s): asset pricing, entrepreneurship, inequality, redistribution, taxation
JEL(s): E24, G12, G18, H23, J24, J31, J38
Programme Areas: Labour Economics, Public Economics, Financial Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=10899

We develop a simple general equilibrium model with heterogeneous agents, incomplete financial markets, and redistributive taxation. Agents differ in both skill and risk aversion. In equilibrium, agents become entrepreneurs if their skill is sufficiently high or risk aversion sufficiently low. Under heavier taxation, entrepreneurs are more skilled and less risk-averse, on average. Through these selection effects, the tax rate is positively related to aggregate productivity and negatively related to the expected stock market return. Both income inequality and the level of stock prices initially increase but eventually decrease with the tax rate. Investment risk, stock market participation, and skill heterogeneity all contribute to inequality. Cross-country empirical evidence largely supports the model's predictions.