One of the big stories in sports this summer was “The Decision” by NBA superstar LeBron James to exercise his rights as a free agent and leave his current team for a better deal with another franchise. The media circus around this non-event spurred a few pieces of economic writing – several journalists chronicled the tax implications of LeBron’s choice. The New York Post reasoned that if LeBron decided to play in New York, he would be subject to the state income tax that would send 12.85% of his earnings to the state. Florida, one of the other states he was considering, does not have a state income tax. Kyle Gillis at the Business and Media Institute, summarized this potential impact on Mr. James’ paycheck in his article called LeBronomics. Based on a contract of $96 million, LeBron’s expected value in the market, Gillis estimated “King James” would face the following tax treatment depending on where he decided to go:
- Florida (Miami Heat) – $0
- Ohio (Cleveland Cavaliers) – $5.69 million
- New Jersey (New Jersey Nets) – $10.32 million
- New York (New York Knicks) – $12.34 million
Though this was surely one of many factors that had an impact on LeBron’s decision, it’s easy to see why he decided to play in Miami.
This got me thinking. Do entrepreneurs consider the impact that state taxes will have on their businesses and their future income when they start their companies? To test this hypothesis, I decided to compare state income tax rates with the Kauffman Index of Entrepreneurial Activity to see if the states with low or no income tax burdens exhibited more entrepreneurial activity. Since eight states (Alaska, Delaware, Florida, Nevada, South Dakota, Texas, Washington and Wyoming) have no state income tax, this hypothesis should show that states with no income tax have higher rates of entrepreneurial activity. Similarly, states that have income taxes lower than other states should also report more startup activity. This would indicate that entrepreneurs are more likely to start their companies in states where the income tax burden is lower, which could provide an interesting indicator for policymakers who want to increase the level of entrepreneurial activity in their state.
With the help of my colleague Connor Schake, I ran the data.
This chart orders all of the states according to their index scores. As one might expect, the states with no income tax (in red) are ranked higher on the chart (with other notable states indicated in green). Though Washington seems to be the lone exception, this chart seemingly proves this hypothesis. But when I sliced the data a little differently, a different picture began to emerge.
Since each state with an income tax structures their taxes a little differently, I ranked the states according to their lowest state income tax bracket and then again according to their highest.
One would expect that these regression lines would be a little steeper – instead this chart shows only a small correlation.
The Small Business Administration reached a similar conclusion in a 2006 study called State Tax Policy and Entrepreneurial Activity stating that, “state tax policy, including both tax rates and the type of taxes in a state’s portfolio, has only a modest effect on aggregate state entrepreneurship rates.”
To me, this “modest effect” means that people are going to start companies no matter where they are. Entrepreneurs want to set out on their entrepreneurial path in familiar surroundings, where their families are based and where their networks are the strongest. In other words, they are unlikely to uproot their lives to start their business. But, maintaining a lower income tax burden certainly doesn’t hurt startup activity.
I wonder if LeBron James will use any of the money he will save by moving to Miami to invest in any startup companies?
To see the full version of the graphs referenced in the Lebrontrepreneurship Blog Post, download the Lebrontrepreneurship Graphs PDF, located below:
LeBrontrepreneurship_Graphs.pdf (186.55 kb)