ASSET DEMAND AND WELFARE COST OF CAPITAL INCOME TAXES IN A LIFE-CYCLE SETTING -AN APPLICATION TO JAPANESE WORKERS HOUSEHOLDS-

Abstract

Using a version of two-asset optimal lifetime consumption model with human wealth, we analyze the effect of income tax on interest on portfolio selection and savings rate as compared to that of capital gains tax and the combined effect of the two taxes. We suggest a method of measuring the welfare cost of capital income taxes in this life-cycle setting and apply it to Japanese workers households classified by cohort. We calculate the ratio of compensation to lifetime expenditures considered as a measurement of the welfare cost. Households who bear these taxes would pay this ratio of lifetime consumption expenditures before taxation so as to avoid remaining the post-tax level of utility. The estimation results show that the welfare cost of both income tax on interest and capital gains tax is between 3% and 7% of the sum of lifetime expenditures at each period after taxation.