Insurer's insolvency risk and tax deductions for the individual's net losses |
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Authors: | Rachel J Huang Larry Y Tzeng |
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Institution: | (1) Finance Department, Ming Chuan University, 250 Zhong Shan N. Rd., Sec. 5, Taipei, 111, Taiwan;(2) Department of Finance, National Taiwan University, No. 1, Sec. 4, Roosevelt Road, Taipei, 10617, Taiwan |
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Abstract: | Using the representative agent approach as in Kaplow (Am Econ Rev 82:1013–1017, 1992b), this paper shows that providing tax
deductions for the individual’s net losses is socially optimal when the insurer faces the risk of insolvency. We further show
that the government should adopt a higher tax deduction rate for net losses when the insurer is insolvent than when the insurer
is solvent. Thus, tax deductions for net losses could be used to provide an insurance for individuals against the insurer’s
risk of insolvency. These findings could also be used to explain why a government provides supplementary public insurance
or government relief. Finally, we discuss that, if the individuals are heterogeneous in terms of loss severity, loss probability,
or income level, providing a tax deduction for the individual’s net losses may not always achieve a Pareto improvement, and
cross subsidization should be taken into consideration.
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Keywords: | Tax deduction Insolvency risk Public insurance Government relief Cross subsidization |
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