NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Adverse Selection In Credit Markets and Regressive Profit Taxation

Florian Scheuer

NBER Working Paper No. 18406
Issued in September 2012
NBER Program(s):   AP   EFG   LS   PE   PR

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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Document Object Identifier (DOI): 10.3386/w18406

Published: Scheuer, Florian, 2013. "Adverse selection in credit markets and regressive profit taxation," Journal of Economic Theory, Elsevier, vol. 148(4), pages 1333-1360. citation courtesy of

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