## Risk-Taking and Optimal Taxation with Nontradable Human Capital

_IMF Working Papers, December 1, 1992_

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**Canonical URL:** [Risk-Taking and Optimal Taxation with Nontradable Human Capital](https://www.imf.org/en/publications/wp/issues/2016/12/30/risk-taking-and-optimal-taxation-with-nontradable-human-capital-856)

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## Bibliographic details
- Authors: Zuliu Hu
- Published: December 1, 1992
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451947427.001

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### Summary and research question
- Investigates: What are the effects of taxation on individual/entrepreneurs’ risk-taking behavior?
- Approach: Re-examines the question in a continuous time life-cycle model.
- Central insight: The stream of uncertain income from human capital has systematic effects on demand for the risky physical capital asset.

### Key findings on risk-taking and taxation
- If labor supply is inelastic and real wages are known with certainty, then:
  - A labor income tax will reduce holdings of the risky physical asset.
- If there are random fluctuations in labor income, then:
  - The effect of a labor income tax on demand for the risky physical asset depends on the nature of interaction between wage risk and investment income risk.
  - A labor income tax may raise demand for the risky capital asset if human capital risk and physical capital risk are positively correlated.
- The idiosyncratic risk and nontradability of human capital have systematic implications for demand for risky assets.

### Implications for optimal taxation
- When the insurance and disincentive effects are jointly taken into account:
  - A Pareto efficient tax structure implies a strictly positive tax rate.

### Model and mechanism details (as described)
- Framework: Continuous time life-cycle model.
- Key mechanisms emphasized:
  - Interaction between wage risk and investment income risk.
  - Nontradability of human capital.
  - Insurance effects versus disincentive effects in tax design.

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/30/risk-taking-and-optimal-taxation-with-nontradable-human-capital-856_