Terrence Chorvat (George Mason) presents The Effect of the Taxation of Risky Income on Investment Behavior at the University of Toronto today as part of the James Hausman Tax Law and Policy Workshop Series.  Here is the abstract:

Domar and Musgrave’s article concerning the effects of a full-loss-offset income tax has been a staple of the public finance literature since 1944. Their model of investor behavior with a full-loss-offset income tax predicts that if a variety of conditions are met, investors should shift their portfolios to higher-risk assets since the government is sharing the risk. Their model assumes that taxpayers are capable of calculating their risk preference under a risk-altering tax structure. Despite the model’s prominent role in the literature, the extent to which its predictions match actual economic behavior has yet to be directly empirically examined. In this paper, we use a laboratory experiment to test the hypothesis that individuals are willing to accept more risk when faced with a full-lossoffset income tax. Preliminary data in this experiment indicate that a symmetrical income tax has either no affect on portfolio allocation or might reduce an investor’s willingness to take on risk. These results imply that the model’s predictions may be reliant on unreasonable assumptions of human behavior.