Entrepreneurship, agency frictions and redistributive capital taxation

Abstract

Motivated by the observation that among OECD countries redistribution is negatively correlated with entrepreneurial activity, we examine the implications of entrepreneurial financial frictions for optimal linear capital taxation, in a setting where the government is concerned with redistribution. By including financial frictions, we emphasize the effect of a new channel affecting the equity-efficiency trade-off of redistribution: taxes affect the allocative efficiency of capital and, ultimately, total factor productivity. We find that high tax rates are optimal, provided that they are applied to wealth, rather than risky capital. Under plausible parameter values, we find that the optimal tax on risky capital is lower than that on wealth, and roughly in line with current U.S. levels. This suggests welfare gains from taxing only wealth at a higher rate.