Should There Be An Extra Tax On Successful Entrepreneurs?


Should we tax successful entrepreneurs? That is one of the recommendations of a new paper about occupational choice and the quality of entrepreneurs.

I show that, for a large class of economies, it might be desirable to tax entrepreneurs and give the proceeds to workers. By doing so, the government can improve entrepreneurial self-selection. The tax converts some of the cross-subsidies in the financial intermediation into tax revenue. This revenue is then used to finance the wage subsidies. The overall effect of the policy is to exchange some rich low-type entrepreneurs with poor high- and low-type entrepreneurs. As a result, the average success probability of the entrepreneurs in the economy increases.

Here is the argument as I understand it. First, let's say there are high quality and low quality entrepreneurs. What is a a low quality entrepreneur? One that destroys value rather than creates it. (In my experience, such people are usually entrepreneurs only because they don't have the skills to cut it in a regular job. They chalk it up to the idea that they are just more creative and innovative than everyone else when really they are scatterbrained and ignorant, but are oblivious to their own shortcomings.)

Now, banks and investors don't know for sure who is high quality and low quality. They can try to figure it out, but can never be 100% sure. By taxing the successful entrepreneurs and subsidizing wages with the money, the thresholds shift. It is less attractive to become an entrepreneur and more attractive to stay at your job (which now pays more). Thus, only the more skilled entrepreneurs will be willing to take the risk.

The author points out that he isn't necessarily advocating that this path be followed.

It is worth mentioning that the policy I propose is a pure efficiency result. That is, in some economies, efficiency requires taxing entrepreneurs and giving the proceeds to workers to improve the welfare. The policy simply changes the threshold levels for wealth classes so as to increase the average quality of active entrepreneurs in the economy. In my view, this pure efficiency result enhances equity as well, since richer low-type entrepreneurs are swapped with poorer high- and low-type workers as a result of the policy.

I didn't investigate all the math in this paper, but I have to question the idea behind it for two reasons. First, entrepreneurship has a large luck component. Knowledge, skill, and hard work can improve the odds, but being at the right place at the right time can make a huge difference too. Secondly, I'm not convinced that people pursue entrepreneurship for money. If that is your main goal, you will most likely fail. Most startups aren't YouTube. Most of them take a long time to yield fruit, and people give up before they hit the payday if they aren't in it for something more. Some love the challenge, some love their work, and some just want to change an industry for the better. The money is the icing on the cake (and anyway, most entrepreneurs don't end up rich).

The paper didn't factor in either of these things, so I'm unlikely to think the conclusion is significant. Nonetheless, I find it surprising that someone would even suggest such a policy, so I am pointing it out to give you something interesting to mention to your friends at the next social gathering. (Because if you read this blog, I know you are probably the kind of business geek who does that stuff) If you have a different interpretation of the paper, by all means leave a comment and let me know.