Working Paper: NBER ID: w18406
Authors: Florian Scheuer
Abstract: In many countries, taxes on businesses are less progressive than labor income taxes. This paper provides a justification for this pattern based on adverse selection that entrepreneurs face in credit markets. Individuals choose between becoming entrepreneurs or workers and differ in their skill in both of these occupations. I find that endogenous cross-subsidization in the credit market equilibrium results in excessive (insufficient) entry of low-skilled (high-skilled) agents into entrepreneurship. This gives rise to a corrective role for differential taxation of entrepreneurial profits and labor income. In particular, a profit tax that is regressive relative to taxes on labor income restores the efficient occupational choice.
Keywords: Adverse Selection; Credit Markets; Taxation; Entrepreneurship
JEL Codes: D82; E22; E44; G11; G14; H21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Adverse selection in credit markets (D82) | Distortion of occupational choice (J29) |
| Distortion of occupational choice (J29) | Excessive entry of low-skilled individuals into entrepreneurship (L26) |
| Distortion of occupational choice (J29) | Insufficient entry of high-skilled individuals into entrepreneurship (L26) |
| Regressive profit tax (H29) | Correction of misallocation in occupational choice (J29) |
| Regressive profit tax (H29) | More efficient allocation of entrepreneurial talent (D29) |
| Higher-skilled entrepreneurs (L26) | Lower expected tax burdens (H29) |
| Lower expected tax burdens (H29) | Encouragement of participation in entrepreneurship (L26) |