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Entrepreneurship, Inequality, and Taxation

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  • Césaire Assah Meh

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Paper provided by Bank of Canada in its series Working Papers with number 02-14.

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Length: 56 pages Abstract: This paper confirms the conjecture that the evaluation of tax policy leads to very different conclusions once the role of entrepreneurs is considered. Contrary to previous literature, the author finds that switching from a progressive to a proportional income tax system has a negligible effect on wealth inequality in the United States. This surprising result arises because entrepreneurial activities moderate the effects of the policy change on the wealth distribution. The author shows that proportional income tax reform increases entrepreneurial investment and savings by reducing the marginal income tax rates paid by entrepreneurs. Within the model, an increase in business investment implies a higher demand for labour, which raises the wage rate of workers and drives down the average return to entrepreneurial activities. This general-equilibrium feedback narrows the income and savings gap between workers and entrepreneurs, and, in turn, leads to a reduction in income and wealth inequality. While the elimination of progressive income taxation increases entrepreneurial investments, it has almost no effect on the number of entrepreneurs, as the costs of entrepreneurial activities rise with increasing wages. The model is also able to account for the substantial share of income and wealth held by entrepreneurs, the high savings rate of entrepreneurs relative to workers, and the high concentration of wealth observed in the data.
Date of creation: 2002
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Handle: RePEc:bca:bocawp:02-14

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Keywords: Fiscal policy; Economic models;

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Cited by:
  1. Sagiri Kitao, 2005. "Income taxation with uninsurable endowment and entrepreneurial investment risks," 2005 Meeting Papers 514, Society for Economic Dynamics.
  2. Mariacristina De Nardi & Marco Cagetti, 2005. "Estate taxes, entrepreneuship, and wealth," 2005 Meeting Papers 144, Society for Economic Dynamics.
  3. Yaz Terajima, 2006. "Education and Self-Employment: Changes in Earnings and Wealth Inequality," Working Papers 06-40, Bank of Canada.
  4. Marco Cagetti & Mariacristina De Nardi, 2004. "Taxation, entrepreneurship, and wealth," Staff Report 340, Federal Reserve Bank of Minneapolis.

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