Working Paper: CEPR ID: DP17266
Authors: Corina Boar; Matthew Knowles
Abstract: We study optimal taxation in a model with endogenous financial frictions, risky investment and occupational choice, where the distribution of wealth across entrepreneurs affects how efficiently capital is used. The planner chooses linear taxes on wealth, capital and labor income to maximize the steady state utility of a newborn agent. Most agents in the model are poor, leading to a redistributive motive for taxation. Optimal tax rates can be written as a closed-form function of the size of the tax bases and their elasticities with respect to tax rates.We find that it is optimal to tax capital income because financial frictions reduce the elasticity of capital income with respect to taxes and because capital income taxes prevent excessive entry into entrepreneurship. Optimal wealth taxes are positive but close to zero, since they strongly discourage capital accumulation.
Keywords: Entrepreneurship; Financial Frictions; Taxation
JEL Codes: E2; E6; H2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Optimal capital income taxes (H21) | Discouragement of excessive entry into entrepreneurship (L26) |
| Financial frictions (G19) | Excessive entry into entrepreneurship (L26) |
| Excessive entry into entrepreneurship (L26) | Capital allocation inefficiencies (D61) |
| Wealth taxes (H24) | Deterrence of capital accumulation (E22) |
| Wealth taxes (H24) | Inefficiencies in capital allocation (D61) |
| Capital income taxes (H24) | Reduction of excess return to risky technologies (O39) |
| Capital allocation inefficiencies (D61) | Shift of capital away from high-return opportunities (F21) |