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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
12419.
Length: Date of creation: Aug 2006 Date of revision: Handle: RePEc:nbr:nberwo:12419
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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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