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Entrepreneurial Taxation with Endogenous Entry

  • Florian Scheuer

This paper analyzes Pareto optimal non-linear taxation of profits and labor income in a private information economy with endogenous firm formation. Individuals differ in both their skill and their cost of setting up a firm, and choose between becoming workers and entrepreneurs. I show that a tax system in which entrepreneurial profits and labor income must be subject to the same non-linear tax schedule makes use of general equilibrium (or "trickle down'') effects through wages to indirectly achieve redistribution between entrepreneurs and workers. As a result, constrained Pareto optimal policies can involve low marginal tax rates at the top and, if available, input taxes that distort the firms' input choices. However, these properties disappear when a differential tax treatment of profits and labor income is possible. In this case, redistribution is achieved directly through the tax system rather than "trickle down'' effects, and production efficiency is always optimal.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19235.

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Date of creation: Jul 2013
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Publication status: published as Florian Scheuer, 2014. "Entrepreneurial Taxation with Endogenous Entry," American Economic Journal: Economic Policy, American Economic Association, vol. 6(2), pages 126-63, May.
Handle: RePEc:nbr:nberwo:19235
Note: EFG LS PE PR
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  1. Stefania Albanesi, 2006. "optimal taxation of entrepreneurial capital with private information," 2006 Meeting Papers 310, Society for Economic Dynamics.
  2. Sagiri Kitao, 2008. "Entrepreneurship, taxation and capital investment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(1), pages 44-69, January.
  3. Drew Fudenberg & Jean Tirole, 1991. "Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061414, June.
  4. Douglas Holtz-Eakin & David Joulfaian & Harvey Rosen, 1992. "Entrepreneurial Decisions and Liquidity Constraints," Working Papers 679, Princeton University, Department of Economics, Industrial Relations Section..
  5. Gordon, Roger H, 1985. "Taxation of Corporate Capital Income: Tax Revenues versus Tax Distortions," The Quarterly Journal of Economics, MIT Press, vol. 100(1), pages 1-27, February.
  6. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 175-208, April.
  7. Florian Scheuer, 2013. "Entrepreneurial Taxation with Endogenous Entry," NBER Working Papers 19235, National Bureau of Economic Research, Inc.
  8. Cesaire Meh, 2005. "Entrepreneurship, Wealth Inequality, and Taxation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(3), pages 688-719, July.
  9. Vincenzo Quadrini, 1997. "Entrepreneurship, saving and social mobility," Discussion Paper / Institute for Empirical Macroeconomics 116, Federal Reserve Bank of Minneapolis.
  10. Naito, Hisahiro, 1999. "Re-examination of uniform commodity taxes under a non-linear income tax system and its implication for production efficiency," Journal of Public Economics, Elsevier, vol. 71(2), pages 165-188, February.
  11. Casey Rothschild & Florian Scheuer, 2011. "Optimal Taxation with Rent-Seeking," NBER Working Papers 17035, National Bureau of Economic Research, Inc.
  12. David G. Blanchflower, 2004. "Self-Employment: More may not be better," NBER Working Papers 10286, National Bureau of Economic Research, Inc.
  13. Kanbur, S.M, 1978. "Risk Taking and Taxation : An Alternative Perspective," The Warwick Economics Research Paper Series (TWERPS) 136, University of Warwick, Department of Economics.
  14. Marco Cagetti & Mariacristina De Nardi, 2009. "Estate Taxation, Entrepreneurship, and Wealth," American Economic Review, American Economic Association, vol. 99(1), pages 85-111, March.
  15. 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 455-66, March.
  16. Jane G. Gravelle & Laurence J. Kotlikoff, 1987. "The Incidence and Efficiency Costs of Corporate Taxation when Corporate and Noncorporate Firms Produce the Same Good," NBER Working Papers 2462, National Bureau of Economic Research, Inc.
  17. Stiglitz, Joseph E., 1982. "Self-selection and Pareto efficient taxation," Journal of Public Economics, Elsevier, vol. 17(2), pages 213-240, March.
  18. Feldstein, Martin, 1973. "On the optimal progressivity of the income tax," Journal of Public Economics, Elsevier, vol. 2(4), pages 357-376.
  19. Kihlstrom, Richard E & Laffont, Jean-Jacques, 1979. "A General Equilibrium Entrepreneurial Theory of Firm Formation Based on Risk Aversion," Journal of Political Economy, University of Chicago Press, vol. 87(4), pages 719-48, August.
  20. Christiansen, Vidar, 1988. " Choice of Occupation, Tax Incidence and Piecemeal Tax Revision," Scandinavian Journal of Economics, Wiley Blackwell, vol. 90(2), pages 141-59.
  21. Emmanuel Saez, 2000. "Using Elasticities to Derive Optimal Income Tax Rates," NBER Working Papers 7628, National Bureau of Economic Research, Inc.
  22. Barton H. Hamilton, 2000. "Does Entrepreneurship Pay? An Empirical Analysis of the Returns to Self-Employment," Journal of Political Economy, University of Chicago Press, vol. 108(3), pages 604-631, June.
  23. Diamond, Peter A & Mirrlees, James A, 1971. "Optimal Taxation and Public Production II: Tax Rules," American Economic Review, American Economic Association, vol. 61(3), pages 261-78, June.
  24. Casey Rothschild & Florian Scheuer, 2012. "Redistributive Taxation in the Roy Model," NBER Working Papers 18228, National Bureau of Economic Research, Inc.
  25. Vasia Panousi, 2008. "Capital Taxation with Entrepreneurial Risk," 2008 Meeting Papers 36, Society for Economic Dynamics.
  26. Cullen, Julie Berry & Gordon, Roger H., 2007. "Taxes and entrepreneurial risk-taking: Theory and evidence for the U.S," Journal of Public Economics, Elsevier, vol. 91(7-8), pages 1479-1505, August.
  27. Zeckhauser, Richard & Schelling, Thomas, 1977. "Taxes in fantasy, or most any tax on labor can turn out to help the laborers," Journal of Public Economics, Elsevier, vol. 8(2), pages 133-150, October.
  28. Scheuer, Florian, 2013. "Adverse selection in credit markets and regressive profit taxation," Journal of Economic Theory, Elsevier, vol. 148(4), pages 1333-1360.
  29. R. Glenn Hubbard & William M. Gentry, 2000. "Tax Policy and Entrepreneurial Entry," American Economic Review, American Economic Association, vol. 90(2), pages 283-287, May.
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