Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 73: Risky Taxes, Budget Balance Preserving Spreads and Precautionary Savings

Torbjörn Becker
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Torbjörn Becker: Department of Economics, Postal: Stockholm School of Economics, Box 6501, 113 83 Stockholm, Sweden.

Abstract: 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.

Keywords: Tax risk; precautionary savings

JEL-codes: E21; H31; D81; E2

32 pages, October 1995

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