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Finance and Economics Discussion Series
The Finance and Economics Discussion Series logo links to FEDS home page Taxation of Labor Income and the Demand for Risky Assets
Douglas W. Elmendorf and 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.

Keywords: Taxation, saving, uncertainty

Full paper (3250 KB PDF)

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Last update: July 16, 1997