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Optimal Taxation of Entrepreneurial Capital with Private Information

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  • Stefania Albanesi

Abstract

This paper studies optimal taxation of entrepreneurial capital with private information and multiple assets. Entrepreneurial activity is subject to a dynamic moral hazard problem and entrepreneurs face idiosyncratic capital risk. We first characterize the optimal allocation subject to the incentive compatibility constraints resulting from the private information. The optimal tax system implements such an allocation as a competitive equilibrium for a given market structure. We consider several market structures that differ in the assets or contracts traded and obtain three novel results. First, differential asset taxation is optimal. Marginal taxes on bonds depend on the correlation of their returns with idiosyncratic capital risk, which determines their hedging value. Entrepreneurial capital always receives a subsidy relative to other assets in the bad states. Second, if entrepreneurs are allowed to sell equity, the optimal tax system embeds a prescription for double taxation of capital income – at the firm level and at the investor level. Finally, we show that taxation of assets is essential even with competitive insurance contracts, when entrepreneurial portfolios are also unobserved.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12419.

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Date of creation: Aug 2006
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Publication status: published as Optimal Taxation of Entrepreneurial Capital with Private Information , Stefania Albanesi. in Business Taxation (Trans-Atlantic Public Economics Seminar) , Devereux and Gordon. 2014
Handle: RePEc:nbr:nberwo:12419

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Cited by:
  1. Catarina Reis & Vasia Panousi, 2012. "Optimal Capital Taxation with Idiosyncratic Investment Risk," 2012 Meeting Papers, Society for Economic Dynamics 732, Society for Economic Dynamics.
  2. N. Gregory Mankiw & Matthew Weinzierl & Danny Yagan, 2009. "Optimal Taxation in Theory and Practice," Journal of Economic Perspectives, American Economic Association, vol. 23(4), pages 147-74, Fall.
  3. Borys Grochulski & Tomasz Piskorski, 2006. "Optimal Wealth Taxes with Risky Human Capital," 2006 Meeting Papers, Society for Economic Dynamics 59, Society for Economic Dynamics.
  4. Zhang, Yuzhe, 2009. "Dynamic contracting with persistent shocks," Journal of Economic Theory, Elsevier, vol. 144(2), pages 635-675, March.
  5. Emmanuel Farhi & Mikhail Golosov & Aleh Tsyvinski, 2006. "A Theory of Liquidity and Regulation of Financial Intermediation," Levine's Bibliography 321307000000000326, UCLA Department of Economics.
  6. Vasia Panousi, 2008. "Capital Taxation with Entrepreneurial Risk," 2008 Meeting Papers 36, Society for Economic Dynamics.
  7. Césaire Meh & Yaz Terajima, 2009. "Uninsurable investment risks and capital income taxation," Annals of Finance, Springer, vol. 5(3), pages 521-541, June.
  8. Florian Scheuer, 2014. "Entrepreneurial Taxation with Endogenous Entry," American Economic Journal: Economic Policy, American Economic Association, vol. 6(2), pages 126-63, May.
  9. 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.

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