Credit market efficiency and tax policy in the presence of screening costs

After establishing the existence of capital market equilibrium in the presence of asymmetric information and screening costs, this paper examines tax policies designed to correct the attendant externalities. When projects differ in expected returns it is shown to be ambiguous whether costly private screening weakens or strengthens the case for an interest income tax. However, when projects differ only in riskiness, as in the model of Stiglitz and Weiss, screening opportunities cause the efficiency case for tax intervention to disappear.