Risky Taxes, Budget Balance Preserving Spreads and Precautionary Savings

The paper analyzes the effects on consumption from changes in the riskiness of taxes. It starts by reinterpreting the Sandmo [1970] paper on general capital income risk to the case of risky capital taxation. In his framework the concept of a mean preserving spread (MPS) is used for the risk analysis. In connection with risky taxes it is however possible to explicitly connect the tax risk with the government's budget constraint. In this paper the concept of a budget balance preserving spread (BBPS) is developed and used for the analysis of stochastic taxes. The paper is concluded with a comparison of the effects that a MPS and a BBPS has on consumption decisions. It is shown that the comparative statics results for a BBPS could be different from the results obtained with a MPS.