Taxation of Labor Income and the Demand for Risky Assets.

This article analyzes the effect of labor income risk on the joint saving/portfolio-composition problem. Given decreasing absolute prudence, we find that even when labor income risk increases overall saving, it tends to lower investment in a risky asset. Applying the theory to public finance, we argue that realistic increases to marginal tax rates on labor can cause large enough reductions in after-tax labor income risk to cause significant increases in risky investment. Copyright 2000 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.