Effects of the United States tax system on transitions into self-employment

Abstract

This paper examines the impact of US income and payroll taxes on the decision of wage-and-salary employees to become self-employed. I exploit variations in the tax treatment of wage and self-employment income using the Panel Study of Income Dynamics. Results show that differential taxation has significant effects on the probability of making a transition into self-employment. Reducing an individual's marginal tax rate on self-employment income while holding his marginal wage tax rate constant reduces the probability of entry. Conversely, reducing his relative average tax rate in self-employment increases this probability by a smaller amount.