Working Paper: CEPR ID: DP10899
Authors: Lubo Pstor; Pietro Veronesi
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.
Keywords: Asset Pricing; Entrepreneurship; Inequality; Redistribution; Taxation
JEL Codes: E24; G12; G18; H23; J24; J31; J38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Tax rate (H29) | Skill level of entrepreneurs (L26) |
| Tax rate (H29) | Aggregate productivity (E23) |
| Tax rate (H29) | Expected stock market return (G17) |
| Tax rate (H29) | Income inequality (D31) |
| Income inequality (D31) | Tax rate (H29) |