Asset Prices, Wealth Inequality, and Taxation

We investigate the interplay between asset prices, wealth inequality, and taxation in a dynamic general equilibrium economy populated by multiple agents with heterogeneous risk aversions. Tax revenues are collected from consumption taxes and are equally redistributed to all investors through non-pledgeable government transfers. Taxes address wealth inequality by ensuring stationarity of consumption share distributions and preventing consumption shares of less affluent investors from diminishing toward zero. Higher taxes increase stock risk premia and volatilities by shifting wealth toward poorer risk-averse investors, and tend to decrease stock price-dividend ratios and interest rates. The rise in risk premia and decrease in interest rates benefit more affluent, less risk-averse investors, partially offsetting the impact of higher taxes on their wealth, albeit to a small extent. We find that taxes do not prevent high concentrations of wealth at the top of the wealth distribution due to the investment decisions and tax responses of more affluent investors. We also extend the model to incorporate restricted stock market participation and show that its interplay with taxation increases stock risk premia and volatility, and decreases interest rates