Taxing Entrepreneurs and Workers: A Linear Optimization Approach for Multidimensional Screening

We study optimal taxation in economies with general equilibrium market clearing, where agents with privately known labor skills and entrepreneurial abilities choose between deterministic labor income and risky firm operation. The government observes labor income and realized dividends but not effort or technology shocks. We formulate the multidimensional screening problem as a lottery-based linear optimization, accounting for global incentive constraints, fixed costs and other non-convexities. Optimal policies exhibit tax breaks, which can render net taxes negative, for agents with intermediate entrepreneurial abilities and labor skills above a threshold. General equilibrium strengthens this effect under decreasing returns, as labor-market clearing requires sufficient entry into entrepreneurship, further increasing subsidies for agents with high worker options. In a calibrated U.S. economy, optimal taxes are lower and can be negative for low-profit realizations. Subsidies rise when risk declines and when the frequency of high-ability entrepreneurs in the population diminishes.