Do tax rate cuts encourage entrepreneurial entry?

DOIhttps://doi.org/10.1108/JEPP-01-2012-0002
Pages178-202
Date07 October 2013
Published date07 October 2013
AuthorTami Gurley-Calvez,Donald Bruce
Subject MatterStrategy,Entrepreneurship,Business climate/policy
Do tax rate cuts encourage
entrepreneurial entry?
Tami Gurley-Calvez
University of Kansas Medical Center, Kansas City, Kansas, USA, and
Donald Bruce
University of Tennessee, Knoxville, Tennessee, USA
Abstract
Purpose – Policy makers have long been interested in whether tax policies can be used to encourage
entrepreneurial activity,but prio r studies haveproduced ambiguous results. The pur pose of this paper
is to investigate whether tax rates affect the decision to begin a new entrepreneurial venture.
Design/methodology/approach – The paper uses a 12-year panel of tax return data to examine the
effects of tax rates on entrepreneurial entry.The paper calculates household-level tax rates and employ
multiple measures of entrepreneurship.
Findings – The results offer evidence that cuts in relative tax rates faced by entrepreneurs, either in
the form of higher rates for wage workers or lower rates for entrepreneurs, increase entry. The
magnitudes of these effects suggest that an across the board tax cut would increase entry.
Practical implications – These results suggest that policy makers interested in entrepreneurial
activity should account for the affects of tax policies on entrepreneurial activity in their decision
making.
Originality/value – The data represent the most accurate publicly available tax information.
We expand on previous work by recognizing that many entrepreneurial households also receive
wage-and-salary income and addressing whether the effects differ by degree of entrepreneurship
(e.g. full-time vs part-time). The analysis of households also includes a broader set of entrepreneurs
than prior work, which has typically limited the sample to working-age male household heads.
Ultimately, the paper finds robust results suggesting an effect opposite from much of the previous
literature, but consistent with recent evidence on entrepreneurial exit decisions.
Keywords Entrepreneurs, Self-employment, Tax policy
Paper type Research pap er
Introduction
Entrepreneurs are of particular interest to researchers and policy makers as they are
thought to play a vital role in the economy, providing much of the energy behind job
creation, technological advancement, and overall economic growth. In this paper, we
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/2045-2101.htm
Journal of Entrepreneurship and
Public Policy
Vol. 2 No. 2, 2013
pp. 178-202
rEmeraldGroup Publishing Limited
2045-2101
DOI 10.1108/JEPP-01-2012-0002
The authors are grateful to the US Small Business Administration, which provided a research
grant for this work (Contract No. SBAHQ-03-M-0535 – Small Business Research Using Large
Databases). The dissertation that served as a foundation for this work was also funded in part by
the Ewing Marion Kauffman Foundation, for which Dr Gurley-Calvez is grateful. They also
thank Daniel Feenberg and Jean Roth at the National Bureau of Economic Research for access to
and assistance with the TAXSIM model, Herb Schuetze for many helpful conversations, and
Karie Barbour for expert programming assistance. Additional valuable feedback was provided
by Bill Neilson, Joe Johnson and seminar participants at Vassar College, the University of
Michigan, the University of Tennessee, and the International Institute of Public Finance. For
assistance in procuring the data for this project, They thank the Center for Business and
Economic Research at the University of Tennessee and the Center for Policy Research at
Syracuse University.The contents of this work are solely the responsibility of the authors and do
not necessarily reflect the views of the Kauffman Foundation, or the SBA.
178
JEPP
2,2
address whether marginal tax rates (MTRs), which we view as clear and visible tools
available to policy makers, affect decisions to enter an entrepreneurial activity.
We contribute to a growing body of theoretical and empirical literature that has sought
to address this issue.
Tax rates potentially affect decisions aboutwhe ther to enter into the entrepreneurial
sector or remain in the wage-and-salary sector because the tax system treats
entrepreneurial income differently than wage-and-salary income. Two examples of this
differential treatment were noted by Goode (1949). First, many expenses related to the
entrepreneurial venture are deductible in calculating taxable income, and business
deductions for goods such as automobiles and computer equipment are likely to have
consumption benefits outside of business use. Alternatively, the inability of certain
entrepreneurs – namely the self-employed – to deduct expenses on services (such as
health insurance prior to 1987), generally paid out of pre-tax dollars for wage-and-
salary workers, might deter entrepreneurial entry.
Second, the taxation of many forms of entrepreneurial income depends upon
voluntary compliance, while most wage-and-salary tax payments are withheld by
employers. This allows relative tax burdens to vary even when entrepreneurs and
wage-and-salary workers face the same tax rates for thre e reasons. First, entrepreneurs
might not be aware of their actual tax burden and might mistakenly underreport their
income or neglect to report certain info rmation, or they could face significantly higher
compliance costs even if they report the appropriate level of income[1]. Second, they
might be prompted to seek professional assistance with their taxes, thereby increasing
the likelihood that they learn about legal ways to reduce their tax burden. Finally, some
entrepreneurs might attempt to engage in tax evasion by willfully misreporting income
or expenses or simply failing to file a tax return.
In any study of entrepreneurship, the first challenge is deciding how to measure
entrepreneurial activity. Entrepreneurship as a concept cannot actually be directly
measured; nearly every individual has some element of the entrepreneurial spirit
within. Like all earlier studies, then, we must resort to a measurable proxy for
entrepreneurship. Most studies have examined individual responses on surveys to
questions regarding self-employment activity. We follow a more recent approach
of using federal individual income tax return data to identify entrepreneurs by the
presence of one or more forms of entrepreneurial income, suc h as income from a sole
proprietorship, partnership or small business corporation, as des cribed in more detail
below. Henceforth, our use of the terms “entrepreneur,” “entrepreneurship,” and
“entrepreneurial activity” refer to this more limited but measurable concept.
We use a 12-year panel of tax return data (1979-1990) to examine the effects of tax
rates on entrepreneurial activity. Although the data preclude analysis of the most
recent tax changes, they represent the best publicly available panel of individual tax
data and cover a period of significant changes in tax policy. Tax data yield several
advantages over previous research. First, our data represent the most accurate publicly
available tax information, which we use to generate household-level tax rates. Use of
tax data also eliminates the need to rely on self-reported survey responses to identify
entrepreneurs as we can precisely define what we mean by entrepreneurship and alter
this definition to test the robustness of our results. We also expand on previous work
by recognizing that many entrepreneurial households also receive wage-and-salary
income and addressing whether the effects differ by degree of entrepreneurship
(e.g. full-time vs part-time). Our analysis of households also includes a broader set of
entrepreneurs than prior work, which has typically limited the sample to working-age
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Entrepreneurial
entry

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