Capital Income Taxation and Risk-Taking in a Small Open Economy

How do capital income taxes affect household portfolio choice and growth? Wequot; approach this question within the context of a stochastic model of a small open economy inquot; which taxes on income from domestic capital (equity) and foreign bonds affect householdquot; portfolio choice, welfare and the growth rate of the economy. The theoretical and numericalquot; analysis demonstrates the important role that risk plays in determining the mean and variabilityquot; of growth as well as the conditions under which a higher tax rate can be welfare improving. Toquot; shed more light on the complex theoretical interaction between taxes and risk-taking we estimatequot; a reduced-form multinomial probit model of household portfolio choice using the method ofquot; simulated moments. The empirical evidence is in stark contrast to the conventional wisdom quot; we find that higher taxes make it less likely that the household will hold risky assets.quot