Optimal Taxation of Entrepreneurial Capital with Private Information

41 Pages Posted: 20 Jul 2006

See all articles by Stefania Albanesi

Stefania Albanesi

New York University (NYU) - Leonard N. Stern School of Business; Columbia University, Graduate School of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: April 2006

Abstract

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 constrained-efficient allocations display an intertemporal wedge on entrepreneurial capital that can be positive or negative. The properties of optimal marginal taxes on entrepreneurial capital depend on the sign of this 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. The optimal tax system equalizes after tax returns on all assets, thus reducing the variance of capital returns after tax relative to 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. Even if entrepreneurs can purchase private insurance against their idiosyncratic risk, optimal asset taxes are essential to implement the constrained-efficient allocation if entrepreneurial portfolios are private information.

Keywords: Entrepreneurial capital, optimal taxation, private information

JEL Classification: E6, H2

Suggested Citation

Albanesi, Stefania and Albanesi, Stefania, Optimal Taxation of Entrepreneurial Capital with Private Information (April 2006). CEPR Discussion Paper No. 5647, Available at SSRN: https://ssrn.com/abstract=918484

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