DP17266 Optimal Taxation of Risky Entrepreneurial Capital

Author(s): Corina Boar, Matthew Knowles
Publication Date: April 2022
Keyword(s): entrepreneurship, Financial Frictions, taxation
JEL(s): E2, E6, H2
Programme Areas: Public Economics, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=17266

We study optimal taxation in a model with endogenous financial frictions, risky investment and occupational choice, where the distribution of wealth across entrepreneurs affects how efficiently capital is used. The planner chooses linear taxes on wealth, capital and labor income to maximize the steady state utility of a newborn agent. Most agents in the model are poor, leading to a redistributive motive for taxation. Optimal tax rates can be written as a closed-form function of the size of the tax bases and their elasticities with respect to tax rates. We find that it is optimal to tax capital income because financial frictions reduce the elasticity of capital income with respect to taxes and because capital income taxes prevent excessive entry into entrepreneurship. Optimal wealth taxes are positive but close to zero, since they strongly discourage capital accumulation.