Capital Taxation with Entrepreneurial Risk

Abstract

This paper studies the effects of capital taxation in a dynamic heterogeneous-agent economy with uninsurable entrepreneurial risk. Although it allows for rich general-equilibrium effects and a stationary distribution of wealth, the model is highly tractable. This permits a clear analysis, not only of the steady state, but also of the entire transitional dynamics following any change in tax policies. Unlike either the complete-markets paradigm or Bewley-type models where idiosyncratic risk impacts only labor income, here it is shown that capital taxation may actually stimulate capital accumulation. This possibility emerges because of the general-equilibrium effects of the insurance aspect of capital taxation. In particular, for the preferred calibrated version of the model, when the tax on capital is 25%, output per work-hour is 2.2% higher than it would have been had the tax rate been zero. Turning to the welfare effects of a reform in capital taxation, it is examined how these effects depend on whether one focuses on the steady state or also takes into account transitional dynamics, as well as how they vary in the cross-section of the population (rich versus poor, entrepreneurs versus non-entrepreneurs). * Email address: vasia.panousi@frb.gov. I am deeply indebted to my primary advisor George-Marios Angeletos for his constant support and guidance. I am very grateful to my advisors Mike Golosov and Ivan Werning for extremely constructive feedback and discussions. I would like to thank

Entrepreneurial Taxation with Endogenous Entry

“…In particular, there has been considerable interest recently in using calibrated dynamic general equilibrium models with an entrepreneurial sector, such as those developed by Quadrini (2000), Meh and Quadrini (2004), and Cagetti and De Nardi (2006), to quantitatively explore how various stylized tax reforms affect the equilibrium wealth distribution, welfare, and investment. For instance, Meh (2005) and Zubricky (2007) have studied the effects of moving from a progressive to a flat income tax system in such economies, Cagetti and De Nardi (2009) have analyzed how an elimination of estate taxation would affect wealth accumulation and welfare, and Panousi (2008) and Kitao (2008) have computed the effects of capital taxation on entrepreneurial investment and capital accumulation. Yet none of these studies have aimed at characterizing and computing optimal tax systems in entrepreneurial economies, which is the focus of the present paper.…”

Public versus Private Risk Sharing

“…We assume that in the two agent economy incomes are perfectly negatively correlated 33 , so that if agent 1 has income y l , agent 2 has income y h and vice versa. 34 Consequently, as in the continuum economy, average income in the economy is nonstochastic and equal to 1. In accordance with the continuum economy we also assume that the income process in the two-agent economy is iid over time, with equal probability of each agent being rich in every period.…”

Uninsurable investment risks and capital income taxation

“…6 Note that in Panousi (2008), the portfolio of agents are independent of the initial wealth distribution. All agents of the same type make the same choice of k and b.…”

“…Nevertheless, these studies do not focus on the under-accumulation that results from investment risks. Panousi (2008), using the framework of Angeletos (2003), also studies capital income taxation in the presence of investment…”