{'fraction_non_alphanumeric': 0.01466414380321665, 'fraction_numerical': 0.0, 'mean_word_length': 5.8892508143322475, 'pattern_counts': {'":': 0, '<': 0, '<?xml version=': 0, '>': 0, 'https://': 0, 'lorem ipsum': 0, 'www.': 0, 'xml': 0}, 'pii_count': 0, 'substrings_counts': 0, 'word_list_counts': {'cursed_substrings.json': 0, 'profanity_word_list.json': 0, 'sexual_word_list.json': 0, 'zh_pornsignals.json': 0}}
Income taxation with uninsurable endowment and entrepreneurial investment risks

This paper studies macroeconomic effects of income taxation in an economy where agents face two sources of uninsurable risks: stochastic process of wage earnings ability and idiosyncratic return from entrepreneurial business. The income risks drive precautionary saving and lead to overaccumulation of capital, while underinvestment may result when return from undertaking entrepreneurial projects is uncertain. Additional capital market imperfections such as borrowing constraints or loan premiums faced by entrepreneurs would exacerbate the effects. We construct a dynamic general equilibrium model where agents make an occupational choice between running a business as an entrepreneur and earning salary wage as a worker, which is fairly simple yet captures the key incentive channels that affect tax incidences. We find that low capital tax encourages saving and increases capital stock and aggregate production, but general equilibrium effects (higher wage and higher aftertax return from saving, and compensating tax increase on non-capital income) discourage entrepreneurial investments. A higher capital tax generates the opposite effects, but comes at a cost of increased inequality and welfare deterioration. A more progressive tax system reduces inequality, but curtails both aggregate and entrepreneurial activities. A proportional tax system favors entrepreneurs and encourages their investment, but hurts workers and the poor. The effects of investment policies that effectively target investments can be imperfectly mimicked if we reduce income tax on entrepreneurs’ business income by taxing their income separately at corporate and individual levels without double taxation. ∗I thank Jess Benhabib, Pierpaolo Benigno, Mark Gertler, Martin Schneider and Gianluca Violante, seminar participants at NYU and University of Tokyo, and especially to Mariacristina De Nardi for useful comments and discussions. I am grateful to Tom Sargent for helpful suggestions, guidance and continuous encouragement. All errors are mine.