Risk, Self‐Employment and Differential Income Taxation

Previous research has identified non‐diversifiable risk and a preference for ‘being one’s own boss’ as key determinants of participation in self‐employment. Using a simple model of occupational choice, I show how both factors can cause efficiency losses in a free market economy, and how linear differential occupational taxation can improve on the market outcome. A simulation exercise calibrated with UK data advocates a tax premium on employment incomes and a tax cut for the self‐employed, in order to generate an efficiency gain of around a third of one per cent of GDP.