Taxation of labor income and the demand for risky assets

This article analyzes the effect of labor income risk on the joint saving/p ortfolio-composition problem. Given decreasing absolute prudence, we find t hat even when labor income risk increases overall saving, it tends to lower investment in a risky asset. Applying the theory to public finance, we arg ue that realistic increases in marginal tax rates on labor can cause large enough reductions in after-tax labor income risk to cause significant incre ases in risky investment.