Do tax rate cuts encourage entrepreneurial entry?

Abstract

Purpose – Policy makers have long been interested in whether tax policies can be used to encourage entrepreneurial activity, but prior studies have produced ambiguous results. The purpose 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.