Discussion Paper Details

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Title: Income Inequality and Asset Prices under Redistributive Taxation

Author(s): Luboš Pástor and Pietro Veronesi

Publication Date: October 2015

Keyword(s): asset pricing, entrepreneurship, inequality, redistribution and taxation

Programme Area(s): Financial Economics, Labour Economics and Public Economics

Abstract: 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.

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Bibliographic Reference

Pástor, L and Veronesi, P. 2015. 'Income Inequality and Asset Prices under Redistributive Taxation'. London, Centre for Economic Policy Research.