Relationship between Tax Policy-Entrepreneurship: Role of Corruption

Abstract

The relationship between tax policy and entrepreneurship is complicated, particularly in countries where the presence of corruption could undermine formal regulatory institutions. Using a hierarchy of institutions approach, we hypothesize and test for the effect of corruption (informal institution), tax policy (formal regulatory institutions) and government size (governance) on entrepreneurship. We consider a moderating effect of corruption on the governance-entrepreneurship and tax policy-entrepreneurship relationships. We account for heterogeneity in tax regulations by considering three types of tax policy tools (corporate tax rate, frequency of tax payments, time to pay taxes, personal income tax rate). We also treat entrepreneurial outcomes as heterogeneous by using three measures for entrepreneurship: Necessity entrepreneurship, opportunity entrepreneurship and formal entry density. Our findings demonstrate that heterogeneity in tax policy influences the three types of entrepreneurship in different ways. Further, we find corruption not only directly affects entrepreneurship, but also plays a role in shaping effects of tax policy and governance on entrepreneurship.