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

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.