Entrepreneurial Taxation with Endogenous Entry

Abstract

This paper analyzes Pareto optimal non-linear taxation of profits and labor income in a private information economy with endogenous firm formation. Individuals differ in both their skill and their cost of setting up a firm, and choose between becoming workers and entrepreneurs. I show that a tax system in which entrepreneurial profits and labor income must be subject to the same non-linear tax schedule makes use of general equilibrium (or "trickle down'') effects through wages to indirectly achieve redistribution between entrepreneurs and workers. As a result, constrained Pareto optimal policies can involve low marginal tax rates at the top and, if available, input taxes that distort the firms' input choices. However, these properties disappear when a differential tax treatment of profits and labor income is possible. In this case, redistribution is achieved directly through the tax system rather than "trickle down'' effects, and production efficiency is always optimal.

Nonlinear Tax Incidence and Optimal Taxation in General Equilibrium

“…Our simpler setting, on the other hand, allows us to get a sharper characterization of the effects of taxes on individual and aggregate welfare, and to directly compare our results to the (Mirrlees, 1971) benchmark. Finally, our setting is distinct from those of Scheuer andWerning (2015, 2016), whose modeling of the technology is such that the general equilibrium effects cancel out at the optimum tax schedule, so that the formula of Mirrlees (1971) extends to more general production functions. We discuss in detail the difference between our framework and theirs in Section 3.2 below.…”

“…In the recent optimal taxation literature, there are two strands that relate to our work. First, a series of important contributions by Scheuer (2014); Rothschild andScheuer (2013, 2014); Scheuer and Werning (2015), Chen and Rothschild (2015), Ales, Kurnaz, and Sleet (2015) and Ales and Sleet (2016) form the modern analysis of optimal nonlinear taxes in general equilibrium. Specifically, Rothschild andScheuer (2013, 2014) generalize Stiglitz (1982) to a setting with N sectors and a continuum of (infinitely substitutable) skills in each sector, leading to a multidimensional screening problem.…”

Entrepreneurship and Financial Frictions: A Macro-Development Perspective

“…Given the success of models of entrepreneurship and financial frictions in producing reasonable wealth distributions vis-à-vis the data, these models have been used to analyze the impacts of tax policy (Amand, 2012;Cagetti and De Nardi, 2009;Kitao, 2008;Lee, 2012;Meh, 2005;Scheuer, 2014). They have also been used to analyze business cycle fluctuations, particularly in the aftermath of the 2008 financial crisis (Achdou et al, 2014b;Buera et al, 2014a;Buera and Moll, 2012;Bassetto et al, 2013;Kiyotaki and Moore, 2012;Shourideh and Zetlin-Jones, 2014), where private entrepreneurs play a special role relative to corporations because of the interaction of consumption, saving, and risk that is linked with investment.…”

Non-linear Effects of Taxation on Growth

“…Scheuer (2014) illustrates this issue in a model in which the labor supply of entrepreneurs and workers are complements, so reductions in the entrepreneurial labor supply lead to a decline in the productivity of workers. Our model embodies a natural source of complementarity between entrepreneurs and workers.…”

“…16 Scheuer (2014) discusses another shortcoming of the Diamond-Saez calculation: it implicitly assumes that tax-driven changes in the labor supply of high-income individuals do not a §ect the productivity of other agents in the economy. Scheuer (2014) illustrates this issue in a model in which the labor supply of entrepreneurs and workers are complements, so reductions in the entrepreneurial labor supply lead to a decline in the productivity of workers.…”