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Optimal Taxation of Risky Entrepreneurial Capital

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  • Corina Boar
  • Matthew P. Knowles

Abstract

We study optimal taxation in a model with endogenous financial frictions, risky investment and occupational choice, where the wealth distribution affects how efficiently capital is used. The planner chooses linear taxes on wealth, capital and labor income to maximize the steady state utility of a newborn agent. Most agents in the model are poor, leading to an equity motive for taxation. We calibrate the model to the US economy and find low positive levels of optimal capital income and wealth taxes. We express optimal tax rates as a closed-form function of the size of tax bases and their elasticities with respect to tax rates, highlighting the forces behind the result. Because financial frictions are endogenous, higher capital income tax rates tighten financial frictions and reduce output. Thus, optimal capital income taxes are lower than in models with exogenous frictions.

Suggested Citation

  • Corina Boar & Matthew P. Knowles, 2022. "Optimal Taxation of Risky Entrepreneurial Capital," NBER Working Papers 29961, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:29961
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    JEL classification:

    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue

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