About Taxes and Entrepreneurship
America’s fiscal health remains currently at the heart of most economic policy chatter. We are living in tight fiscal times. Congress has been focusing on reaching agreements on reducing spending and budget battles are expected to wage on throughout much of this year. Since balancing the budget is inseparable from tax policy, we take a quick look this week at how taxes shape incentives for entrepreneurs.
While I have yet to find a person that decided against starting a business because of unfavorable taxation, taxes can certainly act as an additional burden of risk-taking. Certain tax structures have been found to influence entrepreneurship negatively in research experiments. For example, in 2000, Glenn Hubbard and Bill Gentry found through tax records that higher progressivity lowers the probability of an individual choosing entrepreneurship over corporate employment. In 2001, Bob Carroll and co-authors found that entrepreneurial profits were lower in states with higher marginal tax rates. And in a recent Huffington Post article, Tim Kane explained that higher flat-rate taxes have been found to have no effect on entrepreneurial behavior, and argued in favor of adopting a flat tax with a relative high rate. In his blog post “Steeper Taxes, Fewer Entreps, Less Jobs,” Kane further suggests that the taxes entrepreneurs fear most are not corporate, but individual taxes (usually at the top marginal rate), since many of today´s startups are sole proprietorships or Limited Liability Companies (LLCs).
For the most recent analysis, I recommend reading the chapter on tax policy in the Kauffman Foundation´s just-released Rules for Growth, which clearly lays out a roadmap for moving away from taxes on income—that penalize risk-taking, innovation, and employment—and shifting toward a more consumption-based tax system that encourages saving which in turn funds investment. I would only add that we strive to avoid temporary changes and focus on permanent pro-growth provisions to our tax code wherever politically possible.
Our policymakers should also be careful not to slash the budget at the expense of the America´s most important source of new growth—new firms. For example, the research tax credit should be made permanent, and redesigned for optimal results. While young companies (until age 5) employ 12.5 percent of private sector workers, startups create 150 percent of new jobs in the US.
Entrepreneurs can help to grow the economy—a positive and guaranteed way of reducing the budget deficit. Further, while economic growth is obviously not the sole objective in our policymaking, neither is it the sole value of entrepreneurs who move us forward with socially-important objectives, such as public health or a clean environment. There is no question that innovative entrepreneurs—with their new products, processes and approaches, their new markets, and sometimes their entirely new industries—are crucial not just for an economy's long-term growth, but also for many other of society´s goals.
With the role of start-ups as the drivers of job and wealth creation now being so much better articulated and documented, we see increasing attention and recognition from both parties to entrepreneurs. The fact that Chapter 7 of the 2011 Economic Report of the President is fully dedicated to entrepreneurship is a point in case. As all eyes turn to the federal budget and whether to raise the debt ceiling, I hope the President and the Congress will be sure to take a cue from the Hippocratic Oath and ‘first, do no harm’ to America’s best prospects for new private sector jobs and growth—its nascent entrepreneurs.
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Jonathan Ortmans is president of the Public Forum Institute, a non-partisan organization dedicated to fostering dialogue on important policy issues. In this capacity, he leads the Policy Dialogue on Entrepreneurship, focused on public policies to promote entrepreneurship in the U.S. and around the world. In addition, he serves as a senior fellow at the Kauffman Foundation.