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Adverse selection in credit markets and regressive profit taxation

Florian Scheuer ()

Journal of Economic Theory, 2013, vol. 148, issue 4, 1333-1360

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.

Keywords: Multidimensional screening; Credit markets; Entrepreneurial taxation; Occupational choice (search for similar items in EconPapers)
JEL-codes: D5 D8 G1 H2 J6 (search for similar items in EconPapers)
Date: 2013
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:148:y:2013:i:4:p:1333-1360

DOI: 10.1016/j.jet.2013.04.010

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