Taxation, Savings, and Portfolio Choice in a Continuous Time Model

The continuous time model of consumption and portfolio choice is used to examine the effects of taxation of capital income. Several types of taxes on asset returns are analyzed. For utility functions with constant relative risk aversion, the welfare losses under uncertainty equal those in a certainty environment for general capital taxes. Differential tax rates on returns to capital produce larger welfare losses than equal rates on all asset returns. In contrast to other studies, simulated values of the welfare loss from the equal rate tax on returns to capital are smaller. Simulations for differential capital taxes show much greater welfare losses.