Staff Report 340

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Taxation, Entrepreneurship, and Wealth

Marco Cagetti
Mariacristina De Nardi

Published July 1, 2004

Abstract
Entrepreneurship is a key determinant of investment, saving, and wealth inequality. We study the aggregate and distributional effects of several tax reforms in a model that recognizes this key role and that matches the large wealth inequality observed in the U.S. data. The aggregate effects of tax reforms can be particularly large when they affect small and medium-sized businesses, which face the most severe financial constraints, rather than big businesses. The consequences of changes in the estate tax depend heavily on the size of its exemption level. The current effective estate tax system insulates smaller businesses from the negative effects of estate taxation, minimizing the aggregate costs of redistribution. Abolishing the current estate tax would generate a modest increase in wealth inequality and slightly reduce aggregate output. Decreasing the progressivity of the income tax generates large increases in output, at the cost of large increases in wealth concentration.


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