Income Distribution and the Occupational Choices of Entrepreneurs

This article presents a model that analyzes the effects of redistribution on the occupational choices of entrepreneurs. Entrepreneurs can either engage in costly search for projects and produce or become rent-seekers who collect rents for reversing redistribution. The model illustrates that redistribution of aggregate output is possible until a tipping point is reached. Higher levels of redistribution decrease entrepreneurship, employment, and aggregate income. Which level of redistribution is too much depends on the degree of inequality inherent in the firm quality distribution and on the power of rent-seekers to alter redistributive outcomes. An exogenous increase in the ratio of average realized output to output produced at the lowest-productivity firm reduces the gains from entrepreneurship relative to rent-seeking. This happens because entrepreneurs expend search costs to find those high-quality projects that drive up the average production value, but only a few entrepreneurs can realize these big hits. Wages and rent-seeker pay-offs, on the other hand, depend on average realized production. An increase in the power of rent-seekers further reduces the government’s options. The model implies that the government’s ability to redistribute might be declining when inequality rises.