Tax Policies and Entrepreneurship: Relative Tax Rates and Health Insurance Deductibility

Abstract

This project investigates the effects of taxes on entrepreneurship activities in the United States over a twelve-year period, 1979-1990. The study details two prior theoretical models focusing on two aspects of the tax system: (1) the effects of tax policies on the relative risk of the entrepreneurial sector through loss and offsets, and (2) the opportunities for, and benefits of, evasion. Critiquing the theoretical ambiguity of such theoretical models, a model is developed that combines the relative risk framework with evasion opportunities. Using a random effects model, the tax rates the filer would face both as a wage and salary worker and as an entrepreneur are predicted. The data spans from 1979 to 1990, from more than 200,000 tax returns. Employing a duration model and a discrete choice model, the following findings are made: (1) tax rates have important effects on entrepreneurial entry and survival; and (2) decreases in expected marginal tax rates in the wage sector lower the probability of entrepreneurial entry, diminish the survival of existing entrepreneurs, and increase the probability of entrepreneurial exit. The findings are consistent with the predictions of the chosen theoretical model. It is also indicated that entrepreneurs are sensitive to multiple facets of the tax system, including relative tax rates and tax incentives targeted at health insurance. Findings also indicate that tax policy is an effective tool for influencing levels of entrepreneurship in the economy.