We estimate the optimal tax rate on entrepreneurial income in a model with occupational choice and endogenous investment in sweat capital—intangible capital built through owner effort that cannot be pledged or rented. The model is parameterized to match U.S. national accounts and administrative tax data, including the distribution, persistence, and concentration of business income. Accounting for sweat investment fundamentally alters both tax elasticities and optimal tax prescriptions. In our baseline calibration, the optimal tax rate on entrepreneurial income is 33 percent, above the current effective U.S. rate of roughly 20 percent but far below estimates from models that abstract from sweat investment. Models without endogenous sweat capital generate near-zero elasticities and optimal rates above 60 percent. We show that transitional dynamics are quantitatively important: ignoring them overstates both optimal tax rates and welfare gains. Our results imply that endogenous entrepreneurial investment substantially moderates optimal taxation of business income.
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Topic: “Income Taxes and Entrepreneurship”
Start Time: February 18, 2026, 12:30 PM PT
