Academic journal article Contemporary Economic Policy

Taxes and Entrepreneurship in OECD Countries

Academic journal article Contemporary Economic Policy

Taxes and Entrepreneurship in OECD Countries

Article excerpt

I. INTRODUCTION

In recent years, there have been heated debates in the United States (1) and some European Union countries about taxation and economic growth. There are people who believe that without more tax revenues, their economies will not be able to sustain the economic growth needed to absorb the high levels of excess unemployment. Taxes, they maintain, provide governments (central or federal, as well as state governments) an essential source of revenues which they can use to create public sector jobs and pay for services provided to citizens who need assistance, and this in turn may help sustain a good level of economic growth. Those on the opposite side of the debates argue that this is exactly what governments must avoid for economic growth to be sustained, as more taxes and higher tax rates would lead to a slowdown in growth. In some cases, and depending on the kind of tax that is being levied, higher tax rates may induce individuals to substitute leisure for work, reducing employment and growth. This is even more so in the case of entrepreneurial activity where the self-employed may have more discretion on altering the amount of work or effort in response to changes in taxation.

The structure of taxes is, in general, reflected in tax rates and tax regulations, and many Organization for Economic Co-operation and Development (OECD) countries have had or are having major debates on which tax rates are appropriate. On the one hand, the "incentives" to entrepreneurship (small businesses) argument support a reduction in income taxes. On the other hand, those who support a "social equity" argument advocate an increase in taxes on incomes that often start at the level of incomes generated from small business ownership. Given that many studies have shown that small businesses (entrepreneurship) could be a major driving force for growth, (2) exploring how taxation impacts entrepreneurship (unincorporated enterprises) is a worthwhile undertaking. The case of OECD countries is useful to study primarily because they have for the most part economies at comparable levels of development (in particular Germany, France, United Kingdom, United States, Japan, Canada, and Australia); yet the rates of both established and nascent entrepreneurship are significantly different across countries (see Figure 1).

The primary goal of this article is to explore how taxation affects two types of entrepreneurship--nascent entrepreneurs and established business owners--in a large group of OECD countries, including the United States. More specifically, I try to answer three questions: (1) How do average and marginal tax rates affect entrepreneurship in OECD countries? (2) How does tax progressivity affect entrepreneurship? (3) Are these effects different for different entrepreneurial activity measures? 1 find that changes in marginal and average tax rates do not have a significant impact on entrepreneurship, while higher tax progressivity discourages entrepreneurial activity measured by nascent enterprises, but has no influence on established business ownership. Thus, tax progressivity is found to influence different types of entrepreneurial activity differently.

Many studies have examined the effects of taxes on entrepreneurship (or self-employment). The bulk of the literature, however, uses microlevel data. The few studies that have used macrolevel data tend to employ single-country time series instead of panel data. Moreover, to my best knowledge, with the exception of Baliamoune-Lutz and Garello (2014) there are no empirical studies that have used cross-country panel datasets to explore the effects of tax progressivity on entrepreneurship at the macro level. The most important contribution of this article is the comparison of tax impacts on two different measures of entrepreneurial activity, established and nascent entrepreneurship rates.

The remainder of the article is organized as follows. Section II provides a brief review of the empirical and theoretical literature on the effects of taxes on entrepreneurship. …

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