Shahabeddin Gharaati (RHUL) “The welfare effects of introducing a tax on a collateralized loan” – PhD Seminar

In this paper, I examine the effects of introducing a tax on social welfare in models with collateral and default. Two models are considered. The first model incorporates default and collateral in a standard two-period general equilibrium with incomplete markets; the second is a model with a continuum of investors in the binomial economy who have different beliefs about the asset’s price. The individual that issues the security pays tax in the first period, then all agents receive a transfer in the second period. In both models, the borrower demand for the collateralizable durable good decreases. The borrower is worse off due to an increase in the interest rate and a negative income effect.  On the other hand, a taxation policy benefits the lender through the effect of the tax on the equilibrium interest rate and the equilibrium price of the durable good. In the model with different beliefs, the utilitarian welfare function always increases; however, in the standard model, the social welfare function increase depends on the distribution of endowments of the perishable good in the first period.