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Adverse Selection In Credit Markets and Regressive Profit Taxation

Listed author(s):
  • 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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File URL: http://www.nber.org/papers/w18406.pdf
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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
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. Nick Netzer & Florian Scheuer, 2009. "Competitive Screening in Insurance Markets with Endogenous Wealth Heterogeneity," SOI - Working Papers 0907, Socioeconomic Institute - University of Zurich, revised Jun 2009.
  2. Kleven, Henrik & Kreiner, Claus Thustrup & Saez, Emmanuel, 2006. "The Optimal Income Taxation of Couples," CEPR Discussion Papers 5978, C.E.P.R. Discussion Papers.
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  6. 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.
  7. Innes, Robert, 1993. "Financial Contracting under Risk Neutrality, Limited Liability and Ex ante Asymmetric Information," Economica, London School of Economics and Political Science, vol. 60(237), pages 27-40, February.
  8. Florian Scheuer, 2014. "Entrepreneurial Taxation with Endogenous Entry," American Economic Journal: Economic Policy, American Economic Association, vol. 6(2), pages 126-163, May.
  9. Gordon, Roger H., 2010. "Taxation and Corporate Use of Debt: Implications for Tax Policy," National Tax Journal, National Tax Association, vol. 63(1), pages 151-174, March.
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  12. Rothschild, Casey & Scheuer, Florian, 2014. "Optimal Taxation with Rent-Seeking," CEPR Discussion Papers 10247, C.E.P.R. Discussion Papers.
  13. Simon C. Parker, 2003. "Asymmetric information, occupational choice and government policy," Economic Journal, Royal Economic Society, vol. 113(490), pages 861-882, October.
  14. Philippe Choné & Guy Laroque, 2009. "Negative marginal tax rates and heterogeneity," IFS Working Papers W09/12, Institute for Fiscal Studies.
  15. Jullien, Bruno, 1997. "Participation Constraints in Adverse Selection Models," IDEI Working Papers 67, Institut d'Économie Industrielle (IDEI), Toulouse.
  16. Casey Rothschild & Florian Scheuer, 2013. "Redistributive Taxation in the Roy Model," The Quarterly Journal of Economics, Oxford University Press, vol. 128(2), pages 623-668.
  17. 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.
  18. J. A. Mirrlees, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Oxford University Press, vol. 38(2), pages 175-208.
  19. Mariacristina De Nardi & Phil Doctor & Spencer D. Krane, 2007. "Evidence on entrepreneurs in the United States: data from the 1989–2004 survey of consumer finances," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q IV, pages 18-36.
  20. 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.
  21. Parker, Simon C., 1999. "The optimal linear taxation of employment and self-employment incomes," Journal of Public Economics, Elsevier, vol. 73(1), pages 107-123, July.
  22. Jean-Charles Rochet & Philippe Chone, 1998. "Ironing, Sweeping, and Multidimensional Screening," Econometrica, Econometric Society, vol. 66(4), pages 783-826, July.
  23. David de Meza & David C. Webb, 1987. "Too Much Investment: A Problem of Asymmetric Information," The Quarterly Journal of Economics, Oxford University Press, vol. 102(2), pages 281-292.
  24. Parker, Simon C, 1997. "The Distribution of Self-Employment Income in the United Kingdom, 1976-1991," Economic Journal, Royal Economic Society, vol. 107(441), pages 455-466, March.
  25. 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.
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