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Adverse Selection In Credit Markets and Regressive Profit Taxation

  • Florian Scheuer

In many countries, taxes on businesses are less progressive than labor income taxes. This paper provides a justification for this pattern based on adverse selection that entrepreneurs face in credit markets. Individuals choose between becoming entrepreneurs or workers and differ in their skill in both of these occupations. I find that endogenous cross-subsidization in the credit market equilibrium results in excessive (insufficient) entry of low-skilled (high-skilled) agents into entrepreneurship. This gives rise to a corrective role for differential taxation of entrepreneurial profits and labor income. In particular, a profit tax that is regressive relative to taxes on labor income restores the efficient occupational choice.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18406.

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Date of creation: Sep 2012
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Publication status: published as Scheuer, Florian, 2013. "Adverse selection in credit markets and regressive profit taxation," Journal of Economic Theory, Elsevier, vol. 148(4), pages 1333-1360.
Handle: RePEc:nbr:nberwo:18406
Note: AP EFG LS PE PR
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  1. Jullien, Bruno, 1997. "Participation Constraints in Adverse Selection Models," IDEI Working Papers 67, Institut d'Économie Industrielle (IDEI), Toulouse.
  2. Boadway, Robin & Marchand, Maurice & Pestieau, Pierre, 1991. "Optimal linear income taxation in models with occupational choice," Journal of Public Economics, Elsevier, vol. 46(2), pages 133-162, November.
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  8. Florian Scheuer, 2013. "Entrepreneurial Taxation with Endogenous Entry," NBER Working Papers 19235, National Bureau of Economic Research, Inc.
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  18. Philippe Choné & Guy Laroque, 2009. "Negative marginal tax rates and heterogeneity," IFS Working Papers W09/12, Institute for Fiscal Studies.
  19. Armstrong, Mark & Rochet, Jean-Charles, 1999. "Multi-dimensional screening:: A user's guide," European Economic Review, Elsevier, vol. 43(4-6), pages 959-979, April.
  20. Nick Netzer & Florian Scheuer, 2010. "Competitive screening in insurance markets with endogenous wealth heterogeneity," Economic Theory, Springer, vol. 44(2), pages 187-211, August.
  21. Gordon, Roger H., 2010. "Taxation And Corporate Use Of Debt: Implications For Tax Policy," National Tax Journal, National Tax Association, vol. 63(1), pages 151-74, March.
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  23. Ghatak, Maitreesh & Morelli, Massimo & Sjostrom, Tomas, 2007. "Entrepreneurial talent, occupational choice, and trickle up policies," Journal of Economic Theory, Elsevier, vol. 137(1), pages 27-48, November.
  24. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
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