Thursday, October 11, 2012
John Brooks (Georgetown) presents Taxation, Risk, and Portfolio Choice: The Treatment of Returns to Risk Under a Normative Income Tax, 66 Tax L. Rev. ___ (2013), at Columbia today as part of its Tax Policy Colloquium Series hosted by Alex Raskolnikov, David Schizer and Wojciech Kopczuk:
Consumption tax proponents often assert that a pure Haig-Simons income tax imposes nearly the same burden as a consumption tax, since both largely exempt capital income. Under an income tax, an investor can shift her portfolio toward risky assets so that the increased gain (or loss) exactly offsets any income tax (or deduction) on the returns to risktaking. This article argues, however, that while it is em>possible for an investor to make such portfolio shifts, she almost certainly will not because of the increased risk of doing so.
Central to any discussion of the effects of taxation on investment risk-taking is the meaning of risk itself. The central claim of this article is that a better conception of investment risk is the risk of loss and not merely the variance of returns. Applying this notion of risk -- one that is well supported in finance literature but new to the taxation-and-risk literature -- to an investor’s portfolio choice question shows that an investor will not shift her portfolio toward risky assets by enough to offset the tax. As a result, there is a material tax burden on investment risk-taking under a normative income tax.