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A Flat Tax Reform in an Economy with Occupational Choice and Financial Frictions

Authors


  • Corresponding author: Radim Boháček Economics Institute, Politickych veznu 7, 111 21 Prague 1, Czech Republic. Email: radim.bohacek@cerge-ei.cz

  • We are grateful to the Grant Agency of the Academy of Sciences of the Czech Republic for financial support (grant IAA700850602). This study uses data from SHARELIFE release 1, as of 24 November 2010 or SHARE release 2.5.0, as of 24 May 2011. The SHARE data collection has been primarily funded by the European Commission through the fifth framework programme (project QLK6-CT-2001-00360 in the thematic programme Quality of Life), through the sixth framework programme (projects SHARE-I3, RII-CT- 2006-062193, COMPARE, CIT5-CT-2005-028857, and SHARELIFE, CIT4-CT-2006-028812) and through the seventh framework programme (SHARE-PREP, 211909 and SHARE-LEAP, 227822). Additional funding from the US National Institute on Aging (U01 AG09740-13S2, P01 AG005842, P01 AG08291, P30 AG12815, Y1-AG-4553-01 and OGHA 04-064, IAG BSR06-11, R21 AG025169) as well as from various national sources is gratefully acknowledged (see http:www.share-project.org for a full list of funding institutions). We have received valuable comments and suggestions from the editor and referees, seminar participants at Universidad Autonoma in Barcelona, CREI, DIW Berlin, CERGE-EI and the 2006 SED Meetings in Vancouver. All errors are our own.

Abstract

This article studies a flat tax reform and capital tax reform in an economy with occupational choice and borrowing constraints. Building on previous models with heterogeneous agents and the flat tax reform within the representative firm framework, we introduce entrepreneurs as an occupation. We model endogenous entry and exit of firms whose size, number and production decisions are affected by the tax system. We compare steady state allocations in the benchmark economy with a progressive tax schedule to steady states with a flat tax at different exemption levels with or without a capital tax reform. We find that for low exemption levels the flat tax reform is efficient as well as welfare improving for both occupations.

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