Steeper Taxes, Fewer Entreps, Less Jobs

Today, HuffPo ran my contribution to the Kauffman series, and given the mid-April timeframe, what better topic than tax reform? 

[T]he taxes entrepreneurs fear most are not corporate, since many startups these days are sole proprietorships or Limited Liability Companies (LLCs). They pay individual taxes, the good old 1040, not corporate taxes. More often than not, they're paying the top marginal rate.

The theory is that when the top marginal tax rate goes up, entrepreneurship goes down. In 2000, Glenn Hubbard and Bill Gentry examined tax records and found that higher progressivity lowers the probability of an individual choosing entrepreneurship over corporate employment. A year later, Bob Carroll and co-authors found that entrepreneurial profits were lower in states with higher marginal tax rates.

Over the last couple of years, I've been conducting economic experiments to see if progressive taxes affected entrepreneurial behavior, and early (unpublished) results confirm the empirical studies, with a surprising twist: Making taxes more progressive (that is, raising tax rates on the rich while lowering them for everyone else) lowers the incentive for people to take risks that might make them rich. But the surprise was that higher flat-rate taxes had no effect on entrepreneurial behavior. 

Read the whole thing here.



Comments

[Jeff Knutson]

Mythology is more like it.

I am a small business owner. I can tell you that tax breaks don't spur small business start-ups. Most small businesses lose money for several years. Tax deductions or lower tax rates don't benefit you when you're taking a loss.

Your argument about lower taxes spurring entrepreneurship are refuted by the higher rate of entrepreneurship in Norway, which has higher taxes and a steeper progression in tax rate.

Finally, we've cut taxes for the wealthiest Americans almost every year since the late '60's. During that time the rich have gotten richer, the middle class has shrunk and the deficit has grown.

Insanity is doing the same thing and expecting different results. That appears to be what you are advocating

[Hyena]

What's the mechanism?

Your article seems to suggest that having a progressive tax system with a maximum rate of 35% would lead to fewer entrepreneurs than a flat rate of 35%. This seems off since we should be indifferent between the two.

There's also an arbitrage issue: if personal taxes are higher than corporate taxes, then it makes sense to start corporations. Since corporate income is less taxed, you should take as much of your income, and convert as much of your savings, as possible into equity in your company.