Adverse Selection in Credit Markets and Regressive Profit Taxation

35 Pages Posted: 22 Sep 2012 Last revised: 17 Apr 2023

See all articles by Florian Scheuer

Florian Scheuer

Stanford University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: September 2012

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.

Suggested Citation

Scheuer, Florian, Adverse Selection in Credit Markets and Regressive Profit Taxation (September 2012). NBER Working Paper No. w18406, Available at SSRN: https://ssrn.com/abstract=2150537

Florian Scheuer (Contact Author)

Stanford University - Department of Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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