I am late commenting on this, but I did see Bruce Bartlett’s post last week asking if proposed tax cuts for small businesses will lead to increased job creation. Bartlett emphatically responds no. He rightly argues that the focus on small business is misplaced, citing the Haltiwanger et al. (2011) work on firm age versus firm size, which shows that young firms, not small firms, have historically been responsible for most job creation (and also job destruction, but firms that survive make up for the failures’ losses).
What Bartlett hints at but does not ask directly, which I pose as an open question, is would these tax cuts be effective in increasing job creation if they were targeted not at small businesses, but young firms? Bartlett cites BLS data that points to a slowdown in the number of new establishments and accompanying jobs created in recent years (which E.J. Reedy and Robert Litan here at Kauffman have documented previously with both BLS and Census data, for both firms and establishments). So, would tax breaks for entrepreneurs help young companies resume their pre-2005 job creation levels and startup rates? My answer is that I don’t think we know.
There is an abundance of what purports to be research on “entrepreneurship and taxes” that concludes taxes matter. These studies are primarily about entry into “entrepreneurship.” See for example Carroll et al. (2000), Bruce and Gurley (2005), Gentry and Hubbard (2004), and Gordon and Cullen (2002). I think in these cases the use of the term entrepreneurship is misleading. Their definition of entrepreneurship derives from measuring tax return data for self-employment/sole proprietorships/partnerships. I see these as primarily about how individuals are incentivized to file their earnings.
There is some evidence from Djankov et al. (2008)—importantly, the authors exclude sole proprietorships and shell businesses set up for tax purposes—that corporate tax rates can influence the number of startups and startup rate. This is why the Kauffman Foundation’s Startup Act recommends the extension of total and partial exemptions from corporate taxes for qualified small businesses for the first few years of their operation.1
Taxes and incentives for investors and those involved in financing young firms is a different tax policy consideration. If you take a look at the Kauffman Firm Survey, you see startups relying heavily on outside debt in the form of bank loans, lines of credit, and credit cards. This evidence provides support for policies supporting access to these formal credit channels.
Considering startups seeking outside investors, changes in the capital gains tax could perhaps nudge investors, who are facing a choice between investing in an established company or a young company, to direct more of their investments towards young firms. Such a policy for capital gains tax breaks is also detailed in the aforementioned Startup Act.
Overall, we still have a lot to learn about how tax policy can affect entrepreneurship and job creation. An encompassing study and solid recommendation on the intersection of entrepreneurs and tax policy one way or the other I think is lacking.
1 A note: most startups are small and thus fall under the “qualified small business” classification. But a small portion each year are large, high-growth firms and would not qualify for the tax breaks. I don't know if startups that surpass the small business definition are dealing with immediate success and perhaps are in less need of tax relief, or they are prime targets for tax relief to facilitate faster growth. If I had to hazard a guess, I would say the former, but could be persuaded.
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