Uncertainty and the Theory of Tax Incidence in a Stock Market Economy*

Commencing with Harberger's [1962] classic paper, a number of studies2 have analyzed the incidence of taxation in the context of a deterministic, two-sector, two-factor general equilibrium model. Recently, R. N. Batra [1975] and R. A. Ratti and P. Shome [1977a, 1977b] have reexamined the robustness of these deterministic results for the case in which production uncertainty is incorporated into the model. By using "entrepreneurial" models in which the firm is assumed to maximize the expected utility of profits, they find that the incidence of taxes depends on the preferences and probability assessments of the entrepreneur, and in general, the deterministic results no longer obtain. Most firms, however, are not owned by a single individual, and Batra and Ratti and Shome do not indicate how appropriate their results are for other ownership forms. In particular, their models do not utilize any form of risksharing arrangements such as those available through the securities markets. In the presence of a stock market, it will be shown that the deterministic results of Harberger continue to hold for the firm in their economy if the firm has publiclytraded securities and acts in the best interests of its shareholders. With this shareholders' interests criterion and the Batra-Ratti-Shome model, the securities market is sufficient to separate the production decisions of the firm from the portfolio-consumption decisions of shareholders.3 In a related analysis, Baron and Forsythe [1979] focus on the role of the securities market in establishing unanimity among shareholders about the value maximization criterion for firms. Here, the emphasis is on the impact of taxes on production and factor rewards. Because of separation and the Harberger assumption that aggregate demand is unaffected by the tax rate, the equilibrium in the securities, output, and factor markets has the same qualitative properties as in a deterministic model, and the standard propositions regarding the incidence of taxation continue to hold. If we alter the Harberger assumption that there is no direct tax effect, we will show that a sufficient condition for his results to continue to hold is that all individuals exhibit nondecreasing absolute risk aversion. For expositional purposes only, the analysis will be limited to the study of the effect of the corporate income tax,