Progressive taxation, moral hazard, and entrepreneurship

This paper considers the general equilibrium and welfare effects of a linear progressive income tax with entrepreneurship and moral haz-ard. A competitive intermediation sector diversifies risk associated with entrepreneurial activity, but full risk consolidation is prevented by moral hazard. Since effort is not observable, risk bearing of en-trepreneurs is required for incentive reasons. The extent of risk con-solidation is endogenously explained. We find that a nonredistribu-tive tax is neutral. A progressive tax always impairs entrepreneurship while the effect on welfare can be positive or zero, depending on the specification of moral hazard. Some results may also depend on the concrete formulation of preferences. 1