On the Diferrence between Income and Consumption Taxes when the Return to Savings is uncertain

The taxation of income is usually criticized for the efficiency loss that results from distorting the intertemporal consumption decision. This argument is rejected in a world where the return to savings is random. It is shown that a distorting marginal tax on uncertain interest income serves as partial insurance and that this effect outweighs the efficiency loss, if only the first marginal dollar in tax revenue is valued less elastically than the last dollar spent on private consumption. A consumption tax - even one with intertemporally differentiated rates - would not provide insurance under these circumstances. The explicit consideration of uncertainty thus gives support to taxes that allow differentiation between the safe wi thdrawal of savings and the random return thereon.