Working Paper: NBER ID: w21668
Authors: Lubos Pastor; Pietro Veronesi
Abstract: Our simple model features agents heterogeneous in skill and risk aversion, incomplete financial markets, and redistributive taxation. In equilibrium, agents become entrepreneurs if their skill is sufficiently high or risk aversion sufficiently low. Under heavier taxation, entrepreneurs are more skilled and less risk-averse, on average. Through these selection effects, the tax rate is positively related to aggregate productivity and negatively related to the equity risk premium. Both income inequality and stock prices initially increase but eventually decrease with the tax rate. Investment risk, stock market participation, and skill heterogeneity all contribute to inequality. Cross-country empirical evidence supports the model’s predictions.
Keywords: income inequality; asset prices; redistributive taxation; entrepreneurship; productivity
JEL Codes: E24; G1; H2; J24; J31; J38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Heavier taxation (H29) | selection of more skilled and less risk-averse entrepreneurs (L26) |
| selection of more skilled and less risk-averse entrepreneurs (L26) | aggregate productivity (E23) |
| Heavier taxation (H29) | decrease in total output (E23) |
| Heavier taxation (H29) | increase in average skill of entrepreneurs (L26) |
| increase in average skill of entrepreneurs (L26) | higher productivity (O49) |
| Heavier taxation (H29) | increase in income inequality (D31) |
| income inequality increases (D31) | consumption inequality increases (F62) |
| Heavier taxation (H29) | decrease in income inequality (D31) |
| Heavier taxation (H29) | lower expected stock market returns (G17) |
| Heavier taxation (H29) | concave relationship with stock prices (G40) |