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Optimal Taxation of Entrepreneurial Capital with Private Information

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  • Albanesi, Stefania

Abstract

This paper studies optimal taxation of entrepreneurial capital and financial assets in economies with private information. Returns to entrepreneurial capital are risky and depend on entrepreneurs’ effort, which is not observed. The presence of idiosyncratic risk in capital returns implies that constrained-efficient allocations display an intertemporal wedge on entrepreneurial capital that can be positive or negative. The properties of optimal marginal taxes on entrepreneurial capital depend on the sign of this wedge. If the wedge is positive, the marginal capital tax should be decreasing in capital returns, while the opposite is true when the wedge is negative. The optimal tax system equalizes after tax returns on all assets, thus reducing the variance of capital returns after tax relative to other assets. If entrepreneurs are allowed to sell shares of their capital to outside investors, returns to externally owned capital are subject to double taxation at the level of the entrepreneur and at the level of the outside investors. Even if entrepreneurs can purchase private insurance against their idiosyncratic risk, optimal asset taxes are essential to implement the constrained-efficient allocation if entrepreneurial portfolios are private information.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5647.

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Date of creation: Apr 2006
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Handle: RePEc:cpr:ceprdp:5647

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Keywords: entrepreneurial capital; optimal taxation; private information;

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  1. Tsyvinski, A. & Golosov, M., 2004. "Optimal Taxation with Endogenous Insurance Markets," 2004 Meeting Papers 124, Society for Economic Dynamics.
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Citations

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Cited by:
  1. Emmanuel Farhi & Mikhail Golosov & Aleh Tsyvinski, 2007. "A Theory of Liquidity and Regulation of Financial Intermediation," NBER Working Papers 12959, National Bureau of Economic Research, Inc.
  2. Catarina Reis & Vasia Panousi, 2012. "Optimal Capital Taxation with Idiosyncratic Investment Risk," 2012 Meeting Papers 732, Society for Economic Dynamics.
  3. N. Gregory Mankiw & Matthew Weinzierl & Danny Yagan, 2009. "Optimal Taxation in Theory and Practice," NBER Working Papers 15071, National Bureau of Economic Research, Inc.
  4. Zhang, Yuzhe, 2009. "Dynamic Contracting with Persistent Shocks," MPRA Paper 23108, University Library of Munich, Germany.
  5. da Costa, Carlos E. & Severo, Tiago, 2008. "Education, preferences for leisure and the optimal income tax schedule," Journal of Public Economics, Elsevier, vol. 92(1-2), pages 113-138, February.
  6. Borys Grochulski & Tomasz Piskorski, 2005. "Optimal wealth taxes with risky human capital," Working Paper 05-13, Federal Reserve Bank of Richmond.
  7. Césaire A. Meh & Yaz Terajima, 2009. "Uninsurable Investment Risks and Capital Income Taxation," Working Papers 09-3, Bank of Canada.
  8. Vasia Panousi, 2008. "Capital Taxation with Entrepreneurial Risk," 2008 Meeting Papers 36, Society for Economic Dynamics.
  9. Florian Scheuer, 2014. "Entrepreneurial Taxation with Endogenous Entry," American Economic Journal: Economic Policy, American Economic Association, vol. 6(2), pages 126-63, May.

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