Adverse Selection In Credit Markets and Regressive Profit Taxation

Florian Scheuer

No 18406, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In many countries, taxes on businesses are less progressive than labor income taxes. This paper provides a justification for this pattern based on adverse selection that entrepreneurs face in credit markets. Individuals choose between becoming entrepreneurs or workers and differ in their skill in both of these occupations. I find that endogenous cross-subsidization in the credit market equilibrium results in excessive (insufficient) entry of low-skilled (high-skilled) agents into entrepreneurship. This gives rise to a corrective role for differential taxation of entrepreneurial profits and labor income. In particular, a profit tax that is regressive relative to taxes on labor income restores the efficient occupational choice.

JEL-codes: D82 E22 E44 G11 G14 H21 (search for similar items in EconPapers)
Date: 2012-09
New Economics Papers: this item is included in nep-cta, nep-pbe and nep-pub
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Published as Scheuer, Florian, 2013. "Adverse selection in credit markets and regressive profit taxation," Journal of Economic Theory, Elsevier, vol. 148(4), pages 1333-1360.

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