Taxation, Entrepreneurship, and Incorporation Status of Self-Employment

Abstract

This paper splits self-employment, which has mostly been used as a proxy for entrepreneurship, into two different entrepreneur types with incorporated and unincorporated businesses. This split sheds light on examining how these two types differ in sensitivity to individual-specific marginal and average income tax rate changes in the US. Thus, I analyze the probability of becoming an incorporated or unincorporated self-employed worker by utilizing logit and IV models. I use the Annual Social and Economic (ASEC) rotating panel data of the Current Population Survey (CPS) from 2005 to 2019 to track a paid employee's decision to become a self-employed worker. My empirical findings show that marginal and average personal income tax rates positively affect the decision to become a self-employed worker with an incorporated business. However, I do not find a statistically significant relationship between the tax rates and entry into unincorporated self-employment. My results are robust to alternative specifications. The positive association between the tax rates and entry into incorporated self-employment might be due to increased opportunities for tax sheltering and income shifting. This might lead to unequal taxation, and the choice of legal form might be distorted by tax considerations.