DP8391 | Inequality, Tax Avoidance, and Financial Instability

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We model the link between inequality and excessive risk taking. In the presence of increasing returns to tax avoidance, the middle class is willing to take non rewarded financial risk despite risk aversion. Electoral pressure may lead an incumbent politician to endorse this excessive risk taking if the right tail of wealth distribution is sufficiently fat. By increasing the scope for tax avoidance, globalization of capital and human capital markets might have increased financial fragility.