Rising Entrepreneurs' Wealth and Its Implications for the Optimal Tax Policies : Interplay between Investment Risk and Human Capital Risk

In this paper, we study the optimal Ramsey taxation of capital and labor income as the wealth share of entrepreneurs increases. We first document a rising trend of entrepreneurs' wealth share in the United States using the Survey of Consumer Finance (SCF) data, then investigate how taxes for capital and labor should be adjusted. To achieve this, we build a tractable endogenous growth model that incorporates uninsurable idiosyncratic earning risks for both workers and entrepreneurs. The aggregate state of the model economy is well represented by the wealth share of entrepreneurs (A). Our result shows that (i) the optimal Ramsey tax for capital is positive and exhibits a U-shape over the range of A due to the interplay between idiosyncratic earning risks for workers and entrepreneurs, and (ii) roughly speaking, the sum of labor and capital taxes is determined by the government budget constraint, while the difference between capital and labor taxes is to yield sufficient human capital that achieves the “Ramsey allocation”. In the baseline calibration, the impact of an increase in A on the optimal capital and labor taxes appears to be marginal currently. However, if entrepreneurs’ wealth share continues to increase, policymakers become unable to ignore its effects