optimal taxation of entrepreneurial capital with private information

This paper studies optimal taxation of entrepreneurial capital and financial assets in economies with private information. Returns to entrepreneurial capital are risky and depend on entrepreneurs' effort, which is not observed. The presence of idiosyncratic risk in capital returns implies that the intertemporal wedge on capital that characterizes constrained-efficient allocations can be positive or negative. The properties of optimal marginal taxes on entrepreneurial capital depend on the sign of the intertemporal wedge. If the wedge is positive, the marginal capital tax should be decreasing in capital returns, while the opposite is true when the wedge is negative. Optimal taxes on other assets should be set according to their correlation with risky productive capital. The intertemporal wedge associated with an asset is greater than the one associated with entrepreneurial capital as long as their correlation is less than one. The optimal tax system tends to reduce the variance of capital returns after tax relative to before tax, while the opposite is true for other assets. If entrepreneurs are allowed to sell shares of their capital to outside investors, returns to externally owned capital are subject to double taxation- at the level of the entrepreneur and at the level of the outside investors.