Entrepreneurship, wealth inequality, and taxation

This paper investigates the importance of entrepreneurship when quantifying the aggregate and distributional effects of switching from a progressive to a proportional income tax system. I find that the distributional consequences of the tax reform in a model economy with entrepreneurs contrast markedly from those in a model economy with no entrepreneurs. The elimination of progressive taxation has a negligible effect on wealth inequality when entrepreneurship is considered but has a large effect when entrepreneurship is omitted. The framework used is an occupational choice model, in which the decision to become an entrepreneur is determined by the ability to manage a firm and by asset holdings. The calibrated economy can account for the high savings rate of entrepreneurs relative to non-entrepreneurs, and the high concentration of wealth observed in the data. (c) 2005 Elsevier Inc. All rights reserved.