Occupational Choice and Profit Taxation Under Informational Asymmetries

This paper develops a simple general equilibrium model with signalling in the presence of adverse selection in the financial market and with occupational choice in the labor market, in order to examine the efficiency cost and incidence of an entrepreneurial profit tax. The model yields an informationally-constrained efficient equilibrium in which the high-productivity agents tend to choose the high-return, high-risk occupation. Three different equilibrium types are identified depending upon the occupational distribution, and the population distribution among agent types is emphasized as one of the determining factors of equilibrium characteristics and tax consequences. As the high-productivity agents become more secure, a stronger signal is necessary, but a lower wage is paid to workers. The tax does not always discourage entrepreneurial activities, but when it does, workers share the tax-burden with entrepreneurs. This paper also highlights the beneficial risk-sharing effects of taxation on risky behavior which have often been neglected in the literature, or analyzed in models where capital market imperfections are not endogenously derived.