Raising the Stakes: How Individual Taxes Affect Risk-Taking by Pass-Through Businesses

Abstract

Pass-through businesses (PTBs) generate over 60 percent of U.S. business income. Despite their economic significance, little is known about how individual taxes affect risk-taking by PTBs. This is important because PTBs are subject to a different tax system than traditional corporations, with characteristics that predict divergent relations between tax rates and risk-taking. We study PTBs using the unique setting of thoroughbred racing and examine how taxes affect the decision to enter thoroughbreds in risky stakes races or less risky allowance races. The setting is advantageous because we can observe the choice between two discrete investment options with varying levels of risk. Using multiple difference-in-differences designs that exploit plausibly exogenous changes in federal and state tax rates, we find that higher taxes discourage risk-taking. Our findings suggest that owners of PTBs still face a significant degree of tax loss asymmetry, which affects investment behavior.