Optimal Taxation of Entrepreneurial Capital with Private Information
This paper studies optimal taxation of entrepreneurial capital with private information and multiple assets. Entrepreneurial activity is subject to a dynamic moral hazard problem and entrepreneurs face idiosyncratic capital risk. We first characterize the optimal allocation subject to the incentive compatibility constraints resulting from the private information. The optimal tax system implements such an allocation as a competitive equilibrium for a given market structure. We consider several market structures that differ in the assets or contracts traded and obtain three novel results. First, differential asset taxation is optimal. Marginal taxes on bonds depend on the correlation of their returns with idiosyncratic capital risk, which determines their hedging value. Entrepreneurial capital always receives a subsidy relative to other assets in the bad states. Second, if entrepreneurs are allowed to sell equity, the optimal tax system embeds a prescription for double taxation of capital income â€" at the firm level and at the investor level. Finally, we show that taxation of assets is essential even with competitive insurance contracts, when entrepreneurial portfolios are also unobserved.
I wish to thank V.V. Chari, Pierre-Andre' Chiappori, Chris Edmonds, Caroline Hoxby, Narayana Kocherlakota, Victor Rios-Rull and Aleh Tsyvinski for helpful conversations. I am grateful to seminar participants at Harvard, Yale, University of Pennsylvania, UCSD, NYU and Columbia and to conference participants at the SED Annual Meeting, the SAET meeting, the NBER Summer Institute, and the European Central Bank for useful comments.
Optimal Taxation of Entrepreneurial Capital with Private Information, Stefania Albanesi. in Business Taxation (Trans-Atlantic Public Economics Seminar), Devereux and Gordon. 2014