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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: Forthcoming: Optimal Taxation of Entrepreneurial Capital with Private Information , Stefania Albanesi. in Trans-Atlantic Public Economics Seminar , Devereux and Gordon. 2014
Handle: RePEc:nbr:nberwo:12419

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  1. Stefania Albanesi & Christopher Sleet, 2006. "Dynamic Optimal Taxation with Private Information," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 1-30.
  2. Narayana R. Kocherlakota, 2005. "Zero Expected Wealth Taxes: A Mirrlees Approach to Dynamic Optimal Taxation," Econometrica, Econometric Society, vol. 73(5), pages 1587-1621, 09.
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  21. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 175-208, April.
  22. Emmanuel Farhi & Iván Werning, 2010. "Progressive Estate Taxation," The Quarterly Journal of Economics, MIT Press, vol. 125(2), pages 635-673, May.
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  24. Rogerson, William P, 1985. "Repeated Moral Hazard," Econometrica, Econometric Society, vol. 53(1), pages 69-76, January.
  25. Hassett, Kevin A. & Hubbard, R. Glenn, 2002. "Tax policy and business investment," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 20, pages 1293-1343 Elsevier.
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Cited by:
  1. Césaire A. Meh & Yaz Terajima, 2009. "Uninsurable Investment Risks and Capital Income Taxation," Working Papers 09-3, Bank of Canada.
  2. 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.
  3. Zhang, Yuzhe, 2009. "Dynamic Contracting with Persistent Shocks," MPRA Paper 23108, University Library of Munich, Germany.
  4. Borys Grochulski & Tomasz Piskorski, 2005. "Optimal wealth taxes with risky human capital," Working Paper 05-13, Federal Reserve Bank of Richmond.
  5. Mankiw, N. Gregory & Weinzierl, Matthew Charles & Yagan, Danny Ferris, 2009. "Optimal Taxation in Theory and Practice," Scholarly Articles 4263739, Harvard University Department of Economics.
  6. Catarina Reis & Vasia Panousi, 2012. "Optimal Capital Taxation with Idiosyncratic Investment Risk," 2012 Meeting Papers 732, Society for Economic Dynamics.
  7. Vasia Panousi, 2008. "Capital Taxation with Entrepreneurial Risk," 2008 Meeting Papers 36, Society for Economic Dynamics.
  8. 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.
  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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