Efficient wealth inequality and differential asset taxation with dynamic agency

This paper characterizes a class of stationary constrained-efficient allocations and optimal taxes in an economy with endogenous firm formation and dynamic moral hazard. I consider an environment in which entrepreneurs hire workers and rent capital to produce output subject to privately-observed shocks and have the ability to both divert capital to private consumption and abscond with a fraction of assets. To provide incentives to invest, high realizations of output must be accompanied by high future consumption, leading to ex-post inequality in the efficient allocation. I show that the distributions of consumption and wealth associated with the stationary efficient allocation exhibit thick right (Pareto) tails, with the degree of inequality monotonically increasing in the number of workers per entrepreneur. This constrained-efficient allocation is then implemented in a general equilibrium model using linear taxes on labour income, risk-free savings and business profits. The tax on entrepreneurs’ savings may be positive or negative, while the tax on business profits depends solely upon the degree of private information and is independent of all technological and demographic parameters.