Comments on “Optimal Capital Taxation with Idiosyncratic
Investment Risk”By Vasia Panousi and Catarina Reis
Haiping Zhang
Singapore Management University
43. Konstanz Seminar
23 May 2012
Related Literature:1. Idiosyncratic income risk and incomplete markets
2. Uninsured income risk and optimal taxation
Ramsey Approach (Insurance)
Mirrlees Approach (insurance vs. Incentive)
Aiyagari (1995), Chamley (2001)
Golosov et. al (2003), Albanesi and Sleet (2006), Golosov et. al. (2010), Golosov et. al. (2011), Fahri and Werning (2010)
Labor income risk
Capital income risk
Aiyagari (1994), Hugget (1993, 1997), Krusell and Smith (1998)
Angeletos and Calvet (2005.2006), Angeletos (2007), Buera and Shin (2007), Cagetti and De Nardi (2006), Meh and Quadrini (2006)
Benhabib, Bisin, Zhu (2011, ECTA)
Main Features:1. A continuous-time heterogeneous-agent model
idiosyncratic capital income risk and no aggregate uncertainty
2. Homothetic preference and CRS production
3. Redefine the net wealth of household i from the lifetime perspective
Risk-free asset:rate of return: Rt
Risky asset:Riskiness: Mean rate of return: rt
Financial wealth Human wealth
Model Solution:1. Sameulson-Merton optimal portfolio choice (Angeletos, 2007)
2tt
σ
R-rt =
Risky investment:
Risk-free investment:
Portfolio share:
Model Solution:
Angeletos and Panousi (2009)
Risk premium required
Precautionary saving
Capital and bonds are perfect substitutes
In the steady state
Complete markets: Deterministic at the aggregate and the individual levels
Incomplete markets: Deterministic at the aggregate level and stochastic at the individual level
If markets cannot provide sufficient private risk-sharing, the government may step in to provide additional public risk sharing in the form of proportional capital income tax.
Impacts of Proportional Capital Income Tax
Insurance effect
The general equilibrium effect:
Intertemporal wedge
Comments1. How do macro aggregates and the welfare of an “average” household respond
to capital income tax during the transitional process?
• upon the policy announcement
• the medium-run adjustment
• the long-run level
The optimal implementation schedule
2. Endogenous incomplete markets
• Strategic default on risk-free bond
• Interactions between public and private risk sharingCrowd-in or crowd-out private risk-sharing (Krueger, et. al. 2011)
• Fundamental causes of limited risk sharing in the private markets
Conclusion1. Very elegantly written and intuitively inspiring
2. Serves as a benchmark for further quantitative analysis
3. Opens a door for the research on a variety of topics
optimal taxation in the presence of cross-sector differences in uninsured risk“Plants in the most volatile sector are subject to at least three times as much uncertainty as plants in the least volatile.” – Castro, Clementi, and Lee (2011)
Endogenous project adoptionwill the public Insurance encourage the adoption of the inherently riskier but more productive projects?
The extensive margin of investment: entrepreneurial entry and exit