Michael Rothschild

Notes on the Effect of Capital Gains Taxation on Non-Austrian Assets

This paper is an attempt to assess the effect of capital gains taxation on non-Austrian assets, such as claims to profits of continuing enterprises. As compared to taxation on an accrual basis, the capital gains tax discourages sales of appreciated assets. This is the lock-in effect. Because assets subject to capital gains taxation are generally held a long time, conventional estimates suggest that the effective rate of capital gains taxation is low. We contend that conventional estimates could seriously underestimate the effective rate of capital gains taxation because they ignore uncertainty. We construct a model which allows us to calculate the value of being able to actively manage a portfolio and use this model to calculate the effective rate of capital gains taxation. For several plausible parameter values the effective rate is significantly higher than estimates under certainty. We also discuss some of the ways in which the lock-in effect may distort the allocation of investment funds and the efficient workings of the capital market.

Variable Earnings and Nonlinear Taxation

We explore the interaction between two facts. The first is that income is variable; the second is that the tax and transfer system transforms before tax income into after tax income in highly non-linear ways. The effect is to penalize (and reward) income variability in a manner which is both substantial and capricious.

17 – EQUILIBRIUM IN COMPETITIVE INSURANCE MARKETS: AN ESSAY ON THE ECONOMICS OF IMPERFECT INFORMATION*

Publisher Summary nThis chapter discusses equilibrium in competitive insurance market. The chapter presents an analysis of competitive markets in which the characteristics of the commodities exchanged are not fully known to at least one of the parties to the transaction. In the insurance market, sales offers that survive the competitive process do not specify a price at which the customers can buy all the insurance they want but instead consist of both a price and a quantity. If individuals were willing or able to reveal their information, everybody could be made better off. By their very being, high-risk individuals cause an externality: the low-risk individuals are worse off than they would be in the absence of the high-risk individuals. However, the high-risk individuals are no better off than they would be in the absence of the low-risk individuals. The government may be able to improve the welfare of each person by compelling purchase of some policy, allowing the market then to offer a different separating equilibrium. The presence of this possibility depends on the shape of the particular indifference curves. With more than two types of consumers, such simple government policies may not be available.