Abstract
This paper investigates the effect of entrepreneurs' personal income tax situations on the growth rates of their enterprises. We analyze the personal income tax returns of a large number of sole proprietors before and after the Tax Reform Act of 1986 and determine how the substantial reductions in marginal tax rates associated with that law affected the growth of their firms as measured by gross receipts. We find that individual income taxes exert a statistically and quantitatively significant influence on firm growth rates. Raising the sole proprietor's tax price (one minus the marginal tax rate) by 10 percent increases receipts by about 8.4 percent. This finding is consistent with the view that raising income tax rates discourages the growth of small businesses.
Highlights
The health and vitality of entrepreneurial enterprises is a matter of substantial policy concern
We find that individual income taxes exert a substantial influence on firm growth rates
Our estimate implies an elasticity of 0.84. This suggests, for example, that a decrease in the marginal tax rate levied on a sole proprietor from 50 percent to 33 percent would lead to an increase in his receipts by about 28 percent
Summary
The health and vitality of entrepreneurial enterprises is a matter of substantial policy concern. In this context, a good deal of attention has been focused on the question of whether the tax system impedes the creation and growth of small firms. Many entrepreneurs believe that it does: As an entrepreneur, I experience first hand the horrors of our tax system. We address the question of why, on a priori grounds, one might expect a sole proprietor’s personal tax situation to affect the growth of his or her enterprise. We find that individual income taxes exert a substantial influence on firm growth rates.
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