Professor Varadarajan Chari

CLA Economics
College of Liberal Arts
Twin Cities
Project Title: 
Taxes, Regulations of Businesses, and Evolution of Income Inequality in the US

The US economy has experienced two secular shifts since the 1980. First, the shares of top income groups in total income have been increasing steadily over the last thirty-five years, contributing largely to the increase in the overall income inequality. At the same time the structure of income within the top groups has shifted: entrepreneurial income has become more important for shaping income inequality. Second, this period coincides with the evolution in the structure of legal forms of organization of US businesses. Since 1980 the share of pass-through entities (S corporations, partnerships, and sole proprietorships), which are taxed based on the individual income tax code (rather than corporate income tax code), in total business receipts almost tripled and accounts now for more than one-third of them. Motivated by these two observations this project aims to address two questions: What are the causes and characteristics of the shift in the way US businesses are organized? and How much has the change in the distribution of the organizational forms of businesses contributed to the rapid increase in income inequality? The researchers will use restricted-access US Census data to provide a detailed empirical characterization of the shift in the organizational forms of US businesses.

This research also addresses idea that the change in the legal structure of the US enterprises is driven by changes in tax policy and implemented regulations, which made organizing businesses as pass-through entities more attractive. In particular the total tax burden of the pass-through entities became significantly lower and access to exogenous financing became easier. Validating this idea uses heterogeneous firms and a general equilibrium model with endogenous choice of the business organization form, and creates simulations with the time varying taxes and regulations of businesses disciplined by the data. As the model replicates the key facts from the data about the shift in the organizational forms, it can be used it to quantify the impact of the changes in taxes and regulations and legal forms of organization on the rise of the top incomes shares in the US.

This project will contribute to the empirical literature on firm dynamics by characterizing in details the shift in the organizational forms of business across industries, age and size groups of firms,and geographical areas. This would be a novel characterization making use of the availability of the unique panel, microeconomic data. Moreover, the project makes a contribution to the macroeconomic theory and literature on the role of firm dynamics for macroeconomic aggregates. This literature so far has abstracted from modeling switches of legal forms of organization, partially due to the computational complexity of the task. Finally, the project contributes to the literature on the causes of income inequality increase by quantifying the role of business organizational forms. The potential findings from the project would provide a guidance for public policies on businesses and tax regulations and illustrate their role for the income inequality.

Project Investigators

Professor Varadarajan Chari
Sebastian Dyrda
Keyvan Eslami
Monica Tran Xuan
 
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