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01/2009

DEPFID Working Paper 1/2009 - Abstract

Voting on the tax rate when attitude to risk depends on skill heterogeneity

Francesco Farina * and Fulvio Fontini **

We set a model in which a population of individuals is segmented in the labour market into two groups: high-skill workers and low-skill ones. Risk exposure consists of a macroeconomic employment risk for which the two groups have diverging probabilities. We investigate how risk affects preferences on the optimal level of the tax rate and show that a crucial role is played by workers’ risk-attitude in advanced and backward economies. In the former, overall production increases as low-skills’ working perspectives worsen, while the opposite is true for the latter. In the  first case, a crucial role is played by low-skill workers, whose behaviour depends on their degree of risk aversion: low-skill high-risk averse individuals will chose a lower tax rate as their risk rises, while the opposite is true for both the low-skill low-risk-averse workers and the high-skill ones. In the case of backward economies, both the high-skills high-risk-averse and the low-skill individuals choose a lower tax rate as their risk increases, while the opposite is true for high-skills low risk-averse workers.

KEYWORDS: Constant Relative Risk aversion, Optimal Tax Rate, Workers’ Heterogeneity.

JEL CLASSIFICATION: H30, H21, J24.

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* DEPFID, University of Siena
** Department of Economics, University of Padua