Flow Taxes, Stock Taxes, and Portfolio Choice: A Generalised Neutrality Result

TL;DR

This paper generalizes the concept of portfolio neutrality under wealth and ownership taxes, identifying conditions under which taxes do not distort optimal portfolio choices, with implications for real-world tax systems like Norway.

Contribution

It extends the neutrality result to a full system of ownership taxes, establishing conditions for distortion-free portfolio choices and classifying distortions when conditions fail.

Findings

We identify three key conditions for portfolio neutrality under ownership taxes.

The combined tax system preserves neutrality when the specified conditions are met.

Non-uniform wealth tax assessment causes significant portfolio tilts, outweighing flow-tax effects.

Abstract

A proportional wealth tax - a levy on the stock of wealth - preserves portfolio neutrality by acting as a uniform drift shift in the Fokker-Planck equation for wealth dynamics. We extend this result to the full system of ownership taxes (eierkostnader) that a shareholder faces: a corporate tax on gross profits, a capital income tax on the risk-free return, a dividend and capital gains tax on the excess return, and a wealth tax on net assets. Each tax modifies the drift of the wealth process in a distinct way - multiplicative rescaling, constant shift, or regime-dependent compression - while leaving the diffusion coefficient unchanged. We show that the combined system preserves portfolio neutrality under three conditions: (i) the capital income tax rate equals the corporate tax rate, (ii) the shielding rate equals the risk-free rate, and (iii) the wealth tax assessment is uniform across assets. When these conditions hold, the after-tax excess return is a uniform rescaling of the pre-tax excess return by the factor $(1-\tau_c)(1-\tau_d)$, and the drift-shift symmetry of the wealth-tax-only case generalises to a drift-shift-and-rescale symmetry. We classify the distortions that arise when each condition fails and show that flow-tax distortions and stock-tax distortions are additively separable: they do not interact. The shielding deduction - a feature of several real-world tax systems, including the Norwegian aksjonaermodellen - emerges as the mechanism that restores the symmetry between equity and debt taxation within this framework. Calibrated to the Norwegian dual income tax, conditions (i) and (ii) hold by institutional design; the only binding distortion is non-uniform wealth tax assessment, which generates portfolio tilts roughly 300 times larger than any residual flow-tax channel.