Optimal Taxation of Entrepreneurial Capital with Private Information
Stefania Albanesi, Columbia University, NBER and CEPR
January 2011 (First version: November 2005)
Abstract
This paper
studies optimal taxation of entrepreneurial capital with private information and multiple assets. Entrepreneurial activity is sub ject 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
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, the intertemporal
wedge on entrepreneurial capital
can be negative, as more capital relaxes the entrepreneur’s incentive
compatibility constraints. Second, differential asset taxation is
optimal. Marginal taxes on financial assets 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 bad states. Third, if entrepreneurs are
allowed to sell equity, the optimal tax system embeds a prescription for double
taxation of capital income- at the firm
level and at the investor level.
Keywords: Entrepreneurial capital; Dynamic moral hazard; Capital risk; Optimal taxes; Double taxation of capital.
Older versions (March 2006): NBER WP 12419, CEPR DP 5647.
This work is based upon work supported by the National Science Foundation. Any opinions, findings, and conclusions or recommendations expressed in this material are those of the author(s) and do not necessarily reflect the views of the National Science Foundation.
Last updated: 2/4/2011.