Collaborative Research: Entrepreneurship, Friction and the Macroeconomy

The effects of taxation on economic inequality and capital accumulation have long been a concern for economists and policy makers. While taxes serve the purpose of redistributing resources from the richest to the poorest, they also have negative effects on household's incentives to work and save and thus reduce economic efficiency. In view of the central importance of this question, it is perhaps surprising that we still do not have analyses of the effects of taxation that incorporate the extreme degree of wealth inequality observed in the data and the key role played by entrepreneurs in shaping such inequality and influencing aggregate investment. The goal of this project is to understand the distribution of income and wealth and how tax policies interact with financial market frictions with particular emphasis on the role of estate taxes, income taxes and capital taxation on entrepreneurial income.

This project consists of three parts. First, it seeks to understand how the tightness of borrowing constraints and the receipt of bequests affect entrepreneurial decisions, aggregate capital accumulation and inequality. Less tight borrowing constraints reduce wealth concentration and allow more people to run an entrepreneurial activity. Moreover, the fact that not all of the bequests are accidental, but some are actually voluntary, generates the emergence of some of the large firms and fortunes observed in the data, and increases wealth concentration.

Second, the project aims at studying and quantifying the effects of estate and income taxation. Preliminary simulations show that eliminating the estate tax would generate very small increases in capital accumulation and in wealth inequality, while increasing the effective tax rate to very high levels would greatly reduce inequality, but would be very detrimental to capital formation and output. Lower taxes on entrepreneurial income would have a large positive effect on production and capital accumulation (more so than capital income taxes), but would also increase wealth concentration.

Third, there is a long tradition in macroeconomics of trying to understand how small shocks, consistent with the order of magnitude of those observed in the data, can generate the type of fluctuations observed over the business cycle. Models with heterogeneity and entrepreneurial choice have the potential to generate the kind of amplification and propagation measured in the data. Aggregate shocks affect entrepreneurs and non-entrepreneurs differently. Business investment and firm size change over the business cycle and, in presence of borrowing constraints, private wealth and firm size in turn affect entrepreneurial choices.

Broader impact: This research project seeks to advance the understanding of the quantitative effect of taxes on capital accumulation and inequality and the role of entrepreneurship over the business cycle. It can thus have an impact on the design of tax policies that are currently being discussed by policy-makers, in particular regarding capital income and estate taxation.