Taxes and Entrepreneurship: A Literature Review and Research Agenda

Abstract

The potential impacts of tax policies on entrepreneurial activity have attracted the attention of researchers and policy makers for several decades. Entrepreneurship and innovation are critical elements of the macroeconomy and small businesses contribute significantly to employment and economic growth. Recognizing this, policy makers have a long history of attempting to encourage small business activity through a variety of attractive tax policies. The effectiveness of these policies hinges critically on the extent to which entrepreneurs actually respond to taxes. The theoretical literature has recognized that taxing the returns to risky activity can actually increase risk-taking, especially in the presence of progressive marginal tax rates and loss offset provisions (Domar and Musgrave, 1944). The empirical literature has been inconclusive, with some studies finding a positive relationship between tax rates and small business activity, others finding a negative relationship, and still others finding no significant relationship at all. In this monograph, we review the existing empirical literature in this area and lay out an agenda for future research. We discuss the many ways in which researchers have measured entrepreneurship and small business activity, as well as the variety of tax rates and other policies that have been explored in prior studies.