Financiers vs. Engineers: Should the Financial Sector be Taxed or Subsidized?

Abstract

I study the allocation of human capital in an economy with production externalities, financial constraints and career choices. Agents choose to become entrepreneurs, workers or financiers. Entrepreneurship has positive externalities, but innovators face borrowing constraints and require the services of financiers in order to invest efficiently. When investment and education subsidies are chosen optimally, I find that the financial sector should be taxed in exactly the same way as the non-financial sector. When direct subsidies to investment and scientific education are not feasible, giving a preferred tax treatment to the financial sector can improve welfare by increasing aggregate investment in research and development.