Research

Working Papers

1. Taxing Top Incomes in a World of Entrepreneurs
   Abstract

   This paper shows that high top marginal income tax rates generate large aggregate output and productivity losses. These losses arise because taxes distort decisions of entrepreneurs, who constitute a large share of high income earners. I identify two novel distortions. The first one is the "productivity investment effect". Top income tax rates distort the productivity accumulation decisions not only of entrepreneurs who are already in the top income bracket but also of those who will become top earners in the future by building up their firms. This is because households are forward looking. Anticipating that they will be subject to the high top income tax rate in the future, these middle-income entrepreneurs find it less optimal to accumulate productivity for their firms now. As a result, they slow down their productivity accumulation process. The second force is the "incorporation timing effect". Successful entrepreneurs grow their firms and then sell their businesses to the corporate sector through incorporation. High top tax rates push these entrepreneurs to sell before their firms reach their full productivity potential. This force is driven by a feature of the tax code: the sale of a firm is treated as capital gains, which are taxed at a lower rate than ordinary income. Therefore, when the top income tax rate gets higher, entrepreneurs tend to use incorporation as a tax shelter and incorporate their firms earlier. Early incorporation timing means entrepreneurs do not have enough time to grow their firms to their full productivity potential. These prematurely incorporated businesses lower productivity in the corporate sector. Both effects imply that even though it targets only a small fraction of households, increasing the top marginal income tax rate generates large output costs by decreasing productivity. Since lower productivity erodes the tax base, in a calibrated model, the revenue-maximizing top income tax rate is 45%.
2. Inheritance, Entrepreneurship, and Estate Taxation
   R&R at Journal of Economic Dynamics and Control
   Abstract

   This paper studies the joint roles of inheritance and entrepreneurship in shaping wealth inequality using a heterogeneous agent, general equilibrium overlapping generations model. The analysis is disciplined by new empirical evidence from the Survey of Consumer Finances on the relative importance of inheritances among very wealthy households. In the data, among households in the richest 1% of the wealth distribution, only about 6% have received inheritances accounting for at least half of their net worth, and more than half report receiving no inheritance at all. Consistent with these facts, the calibrated model implies that inheritances play only a limited role in generating extreme wealth. Using the calibrated model, the paper evaluates estate tax reforms and finds that their effects on wealth concentration are smaller than commonly believed.
3. Learning in the Shadows: Informality and Entrepreneurship in Brazil (with Roberto Lagos Mondragon)
   Rej&R at International Economic Review
   Abstract

   We examine the role of the informal sector in shaping entrepreneurial dynamics. Using Brazilian data, we document two novel empirical facts. First, around one-third of high-income entrepreneurs operate their businesses in the informal sector, and they closely resemble their formal sector counterparts across a range of characteristics. Second, high-income entrepreneurs are more likely to transition into the formal sector over time. These observations raise a central question: Why do these highly productive individuals choose to start out informally and only later formalize? To interpret these findings, we develop a quantitative model featuring imperfect information and learning. Individuals choose between wage employment and entrepreneurship without fully knowing their business potential. Within this framework, the informal sector endogenously arises as a cost-effective platform for entrepreneurial experimentation. Individuals operate informally to gradually learn about their business quality. Entrepreneurs who discover they are highly productive subsequently transition into the formal sector to expand production and access financial markets. The calibrated model replicates the observed transition patterns from informality to formality and generates policy counterfactuals consistent with historical reforms in Brazil. Specifically, the model shows that reducing entry costs alone has limited effects on formalization. In contrast, combining entry-cost reductions with temporary tax relief leads to substantially larger declines in informality. Importantly, the resulting increase in formal-sector firms is driven primarily by the formalization of existing informal businesses rather than by the creation of new formal firms.

Work in Progress

1. Safety Net or Trap: Informal Sector Employment over the Business Cycle (with Irisa Zhou)
   Abstract

   The informal sector is often viewed as a buffer during economic downturns, absorbing workers displaced from the formal sector and mitigating unemployment spikes. Using panel data from Continuous National Household Sample Survey (PNADC) between 2012 to 2018, we examine the short‐ and long‐term consequences of informal employment in Brazil across the business cycle and establish several new empirical facts. We observe that informal sector expands during recession, consistent with the literature, indicating that informal sector acts as a buffer for workers. Our new finding is that a brief spell in the informal sector, lasting at most one quarter, increased the probability of formal re‐entry relative to unemployment. However, prolonged informal employment sharply reduced re‐entry probabilities into formal sector, with this scarring effect persisting after controlling for individual characteristics. To interpret these patterns, we develop a directed search model with human capital depreciation, where depreciation depends on employment type and spell length. The framework captures the observed dual role of the informal sector as both a short‐term safety net and a long‐term trap. When designing labor market policies, our findings show that “when” to act is as important as “what” to do. Preserving the short‐term benefits of the informal sector requires timing as well as targeting, a dimension the literature has largely overlooked.
2. Female Employment in the Informal Sector