Occupational choice and the quality of entrepreneurs

This paper is the first to endogenize both risk-free interest and wage rates in a tractable occupational choice model. Individuals who differ in terms of entrepreneurial ability and wealth choose between entrepreneurship and wage-earning, and the wealth classes form endogenously. Because of the general equilibrium repercussions of policies, whether to tax or subsidize entrepreneurs depends crucially on the shape of the wealth distribution. In particular, a tax on entrepreneurs used to subsidize workers can sometimes increase the average quality of entrepreneurs. Unlike the previous studies, in all of which the risk-free interest rate is exogenous, the policy works by affecting the loan supply to the banks via swapping some low-ability upper-middle-class entrepreneurs with an equal number of high- and low-ability poor-class workers.