Working Paper: NBER ID: w19235
Authors: Florian Scheuer
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.
Keywords: Entrepreneurship; Taxation; Endogenous Entry; Income Redistribution
JEL Codes: D5; D8; E2; E6; H2; J2; J3; J6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| uniform tax schedule (H20) | occupational choice (J29) |
| uniform tax schedule (H20) | redistribution (H23) |
| occupational choice (J29) | redistribution (H23) |
| differential tax treatment (H25) | redistribution outcomes (H23) |
| differential tax treatment (H25) | production efficiency (D24) |