Tax structure and entrepreneurship

Abstract

Using macro level panel data, we examine the effects of taxation and tax progressivity on entrepreneurship in a large group of European countries. We address two main objectives. First, we try to explore whether tax increases discourage entrepreneurial activity, focusing on new self employment (nascent entrepreneurship). Second, we investigate the impact of tax progressivity on entrepreneurship, again focusing on the impact on new self employment. We find that tax progressivity at higher than average incomes has a robust negative effect on nascent entrepreneurship. We discuss the policy implications of our results.

Taxes, start-up costs, and innovative entrepreneurship

“…In fact, high tax re-distributes wealth from successful innovative entrepreneurs to other citizens in society with low or no income (e.g., the unemployed) (Gentry and Hubbard 2000;Baumol et al 2007). Corporate tax can discourage entrepreneurs from engaging in innovative yet risky activities (Balliamoune-Lutz and Garello 2014;Clingingsmith and Shane 2016). When a tax code taxes profits more heavily than it provides tax credits for losses of corresponding size, policy-makers create an incentive to engage in activities that generate income with lower variability.…”

Tax Progressivity and Entrepreneurial Dynamics

“…These outcomes imply the possibility of a 'success' effect, which means that entrepreneurial entry is reduced with an increase in tax progressivity. In recent years, however, both micro-and macro-level empirical literature [14][15][16][17] have provided mixed evidence for this relationship. Consequently, the following theoretical literature has examined why tax progressivity can have positive [7], negative [18,19], or ambiguous effects [20] on entrepreneurial entry.…”

“…Despite these analyses and various cross-national panel examinations, little is known about the relationship between tax progressivity and the transition from nascent entrepreneurship to established business ownership. Two recent studies, [16] and [17], both explored the effect of tax progressivity on entrepreneurial entry at the macro level using cross-national panel analysis. While [16] examines the effect of tax progressivity on nascent entrepreneurship, [17] explores the effect of tax progressivity on entrepreneurial activity by distinguishing two types of entrepreneurship-nascent entrepreneurship and established business ownership.…”

“…Two recent studies, [16] and [17], both explored the effect of tax progressivity on entrepreneurial entry at the macro level using cross-national panel analysis. While [16] examines the effect of tax progressivity on nascent entrepreneurship, [17] explores the effect of tax progressivity on entrepreneurial activity by distinguishing two types of entrepreneurship-nascent entrepreneurship and established business ownership. Both studies found a negative association between tax progressivity and nascent entrepreneurship at higher incomes.…”

“…The main reason for this is that earlier theoretical and empirical works have been unable to provide much guidance on the effect of tax progressivity due to the competing predictions of the 'insurance' and 'success' effect, and no clear theory for when each might apply. Moreover, as Ref [16] (p. 171) note, "Oddly the bulk of the empirical evidence on the impact of average tax rates points to a positive effect on entrepreneurship (self-employment). This difference in the effects of average and marginal tax rates suggests that tax progressivity may play an important role."…”