Taxes and Entrepreneurship: A Literature Review and Research Agenda

Foundations and Trends® in Entrepreneurship
Taxes and Entrepreneurship:

A Literature Review and Research
Agenda
Suggested Citation: Donald Bruce, Tami J. Gurley-Calvez and Alex Norwood (2020),
“Taxes and Entrepreneurship: A Literature Review and Research Agenda”, Foundations
and Trends® in Entrepreneurship: Vol. 16, No. 5, pp 393–443. DOI: 10.1561/0300000079.
Donald Bruce
Douglas and Brenda Horne Professor of Business
Boyd Center for Business and Economic Research
and Department of Economics
University of Tennessee, Knoxville
722 Stokely Management Center, 916 Volunteer Blvd.
Knoxville, TN 37996, USA
Tami J. Gurley-Calvez
Associate Professor
Department of Health Policy and Management
University of Kansas Medical Center
Mail Stop 3044, 3901 Rainbow Blvd.
Kansas City, KS 66160, USA
Alex Norwood
Research Associate
Boyd Center for Business and Economic Research
University of Tennessee, Knoxville
712 Stokely Management Center, 916 Volunteer Blvd.
Knoxville, TN 37996, USA
This article may be used only for the purpose of research, teaching,
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Boston — Delft
Contents
1 Introduction 395
2 Measuring Entrepreneurship 400
3 Measuring Tax Policy 412

3.1 Personal Income Taxes . . . . . . . . . . . . . . . . . . . 414
3.2 Corporate Income Taxes . . . . . . . . . . . . . . . . . . . 415
3.3 Sales Taxes . . . . . . . . . . . . . . . . . . . . . . . . . 416
3.4 Other Taxes . . . . . . . . . . . . . . . . . . . . . . . . . 416
4 Common Problems with Empirical Analysis of Taxes

and Small Business Activity 418
5 Summary of Prior Literature 420

5.1 Studies Focusing on National Taxes . . . . . . . . . . . . 421
5.2 Studies Focusing on Sub-National Taxes . . . . . . . . . . 423
5.3 International Studies . . . . . . . . . . . . . . . . . . . . . 426
6 Synthesis and Directions for Future Research 430
Acknowledgements 434
References 435
Taxes and Entrepreneurship:
A Literature Review and Research
Agenda
Donald Bruce1 , Tami J. Gurley-Calvez2 and Alex Norwood3
1 Boyd Center for Business and Economic Research and Department of
Economics, University of Tennessee, Knoxville, TN 37996, USA;
dbruce@utk.edu
2 Department of Health Policy and Management, University of Kansas
Medical Center, Kansas City, KS 66160, USA; tgurley-calvez@kumc.edu

3 Boyd Center for Business and Economic Research, University of
Tennessee, Knoxville, TN 37996, USA; anorwoo1@utk.edu
ABSTRACT
The potential impacts of tax policies on entrepreneurial ac-
tivity have attracted the attention of researchers and policy
makers for several decades. Entrepreneurship and innova-
tion are critical elements of the macroeconomy and small
businesses contribute significantly to employment and eco-
nomic growth. Recognizing this, policy makers have a long
history of attempting to encourage small business activity
through a variety of attractive tax policies. The effectiveness
of these policies hinges critically on the extent to which
entrepreneurs actually respond to taxes. The theoretical
literature has recognized that taxing the returns to risky
activity can actually increase risk-taking, especially in the
presence of progressive marginal tax rates and loss offset
provisions (Domar and Musgrave, 1944). The empirical lit-
erature has been inconclusive, with some studies finding a
Donald Bruce, Tami J. Gurley-Calvez and Alex Norwood (2020), “Taxes and En-
trepreneurship: A Literature Review and Research Agenda”, Foundations and Trends®
in Entrepreneurship: Vol. 16, No. 5, pp 393–443. DOI: 10.1561/0300000079.
394
positive relationship between tax rates and small business ac-

tivity, others finding a negative relationship, and still others
finding no significant relationship at all. In this monograph,
we review the existing empirical literature in this area and
lay out an agenda for future research. We discuss the many
ways in which researchers have measured entrepreneurship
and small business activity, as well as the variety of tax rates
and other policies that have been explored in prior studies.
1
Introduction
The potential impacts of tax policies on entrepreneurial activity have

attracted the attention of researchers and policy makers for several
decades. Entrepreneurship and innovation are critical elements of the
macroeconomy and small businesses contribute significantly to employ-
ment and economic growth. Recognizing this, policy makers at all levels
of government have a long history of attempting to encourage small
business activity through a variety of attractive tax policies.1 The extent
to which these policies can be effective hinges critically on the extent
to which entrepreneurs actually respond to taxes. In this monograph,
we review the existing empirical literature in this area and lay out an
agenda for future research.
On the surface, it is not clear whether tax policies enhance en-
trepreneurial opportunity, detract from entrepreneurial success, or have
no effect at all. Traditional forms of practical income taxation create
potentially offsetting incentives. Progressive tax rates reduce the returns
to entrepreneurial success, but also provide insurance against losses.
1
Holtz-Eakin (1995) provides a useful discussion of the possible arguments in
favor of targeted subsidies for small or innovative businesses.
395
396 Introduction
Additionally, the traditional income tax structure provides greater op-

portunities for tax avoidance and evasion for self-employed individuals
or others whose income is not reported by a third party, potentially
increasing returns to entrepreneurship. Alternatively, complexities in the
tax code create significant administrative and compliance costs, which
are likely exacerbated by frequent changes in the tax code (Aghion
et al., 2017; Braunerhjelm and Eklund, 2014; Braunerhjelm et al., 2019;
Lignier and Evans, 2012; Nelson, 2008; Weber, 2015). The bottom line is
that while it may be tempting to assume that incentives such as reduc-
tions in tax rates would have positive effects on small business activity,
both the theoretical and empirical literatures have been inconclusive.
The U.S. experience provides several useful examples of the use of
broad-based tax systems to encourage entrepreneurial activity (Gurley-
Calvez and Bruce, 2013). For starters, non-corporate business entities
typically remit their income taxes through the individual income tax as
“pass-through” entities. While wage income is reported to tax authorities
by employers, the general lack of third-party income reporting for
entrepreneurs creates a potentially-meaningful tax wedge even if the
statutory tax rate schedules are the same for all types of earnings.
Limitations in the deductibility of fringe benefits and other business
expenses have been enacted to reduce this potential wedge, but a tax
advantage remains at least as far as income taxes are concerned.
The same is not true for payroll taxes in the U.S., where statutory
rates have varied considerably between wage workers and small business
owners (Bruce, 2000). Before an effort was made to equalize the payroll
tax treatment in 1984, self-employed workers enjoyed a payroll tax rate
that was less than the combined employee and employer payroll tax rate
applied to wages and salaries. Importantly, these broad efforts to level
the federal income and payroll tax playing field between wage workers
and small business owners has created substantial exogenous variation
that has been used to identify effects in a growing number of empirical
studies. Before we turn to an exhaustive review of those studies, we
briefly consider the theory behind them.
The combination of deductibility of business purchases and the lack
of a third party to report income or expenses to tax authorities can
make small business activity attractive relative to wage employment
397
(Goode, 1949). Business purchases often convey consumption benefits

to the small business owner. While this has prompted rules to limit the
deductibility of such things as automobiles, meals, and travel expenses,
it remains possible to combine personal consumption and business
expenses, especially given the absence of third-party reporting. Payments
in cash, both in terms of revenues and expenditures, can also make it
easier for a small business owner to reduce reported net income for tax
purposes (Nelson, 2008). New information reporting requirements such
as 1099-MISC forms, meant to increase compliance, are only effective
to the extent that business owners are aware of these requirements and
file accordingly.
Recent theoretical evidence provides some rationale for different
effective tax rates by entrepreneurial status. Gersbach et al. (2018) find
that higher taxes on labor earnings and lower taxes on firm profits lead
to more entrepreneurship in the economy. However, even if marginal
tax rates and incomes are identical between wage employees and small
business owners, tax burdens can vary for several behavioral reasons.
As discussed by Gurley-Calvez and Bruce (2013), small business owners
might be unaware of various tax rules and might mistakenly underreport
income or fail to disclose other information. They might also face higher
compliance costs given the absence of third-party reporting. On the
other hand, they are potentially more likely to seek out professional
tax-filing assistance and thus might be more aware of various provisions
to enable legal tax avoidance (e.g., a home office deduction). And to be
sure, they can engage in tax evasion by simply underreporting income
or overstating expenses.
Gurley-Calvez and Bruce (2008) provide a useful summary of the
theoretical literature, which has generally yielded ambiguous conclusions
regarding the effects of tax rates or burdens on small business activity.
Considering only the level and variance of self-employment earnings,
Fossen (2007) shows that self-employment is negatively related to tax
rates and the variance in self-employment earnings. Incorporating loss
offsets, but still setting aside the issue of compliance, Bruce (2000, 2002)
and Cullen and Gordon (2007) build upon the more general work of
Domar and Musgrave (1944), who showed that increasing tax rates can
encourage risk-taking in the presence of loss offsets. Specifically, these
398 Introduction
models of relative risk begin with the assumption that wage employ-
ment brings a certain income while small business or entrepreneurial
activity yields unknown income. An increase in the relative tax rate
on entrepreneurial income has two potentially offsetting effects. On
one hand, it reduces the relative return to (and thus discourages)
riskier entrepreneurial activity. On the other hand, the ability to use
entrepreneurial losses to offset other sources of income compresses the
post-tax distribution of entrepreneurial income and provides implicit
insurance against the risk. The extent to which one of these effects
outweighs the other depends on the worker’s preferences over risk and
return. Gordon and Sarada (2018) take the concept of loss offsets further
by showing that refundable loss offsets are the best way to support
entrepreneurial efforts with substantial risk.
Some theoretical studies have focused on the lack of third-party
reporting for income and/or expenses in entrepreneurial activities, which
provides greater opportunity for legal tax avoidance and/or illegal tax
evasion activity. Watson (1985) and Kesselman (1989) are two early
examples of this work, and both find ambiguous effects of tax rates on
small business activity.
Gurley (2005) combined these two broad areas of the theoretical
literature and produced unambiguous conclusions. In her model of
relative risk with opportunities for evasion, she showed that increasing
the relative marginal tax rate on wage income (by increasing the wage
tax rate and/or decreasing the entrepreneurial tax rate) increased one’s
likelihood of reporting entrepreneurial income on a tax return. The
interesting conclusion from her model is that the U.S. tax reforms of
the 1980s should have reduced entrepreneurial income as reported on
tax returns.
The empirical literature has been inconclusive, with some studies
finding a positive relationship between tax rates and small business
activity, others finding a negative relationship, and still others finding
no significant relationship at all. In this monograph, we review those
studies with the goal of identifying themes from their results and laying
out an agenda for future research.
We first discuss the many ways in which researchers have measured
entrepreneurship and small business activity. We explore the various
399
strengths and weaknesses of measures of stocks vs. flows, individual vs.

aggregate analyses, survey vs. administrative data, and extensive vs.
intensive margin indicators of entrepreneurship. We consider the pros
and cons of each and demonstrate that no single measure can capture
every interested person’s preferred concept of entrepreneurship. This
should not be a deterrent to good empirical analysis, however, and we
provide several points of advice and encouragement for those wishing
to contribute to the literature. We then discuss the various tax rates
and other tax policies that have been considered in the literature, again
considering their advantages and disadvantages.
Next, we discuss a few of the major empirical issues facing research
on taxes and entrepreneurship. We begin with a consideration of the
various efforts that have been made to deal with the possible endo-
geneity or simultaneity of tax rates. Following a brief discussion of
the importance of timing issues (including the length of available time
series or longitudinal data sources), we consider the latest econometric
attempts to account for pre-existing trends in entrepreneurship and
tax data.
We then present an exhaustive and inclusive summary of the large
and growing empirical literature on taxes and entrepreneurship. In
an effort to enhance the usefulness of the monograph, we segment
the literature into (a) U.S. federal studies, (b) U.S. state and local
studies, and (c) international studies, and further subdivide each of
these three groups into time series, cross-sectional, and longitudinal
analyses. The literature review concludes with a synthesis of findings
spanning all of the above categories and focusing on what we think are
the most conclusive studies in each area. The monograph concludes
with a discussion of what we view to be the most fruitful avenues for
future empirical research in this area, based on the identified gaps in
the existing literature.
2
Measuring Entrepreneurship
Empirical studies of the effects of taxation on entrepreneurship or small

business activity must eventually struggle with the question of how to
measure the outcome of interest. Bruce and Glenn (2016) provide a
useful discussion of this issue, which we summarize and extend here.
While the concept of entrepreneurship is rather straightforward to
comprehend theoretically, it is virtually impossible to measure in a way
that satisfies every reader. It seems that every possible candidate either
excludes some true entrepreneurs or includes some false ones, and most
suffer both of these fates. Schumpeter (1947, p. 151) summarized this
situation long before most of the studies discussed in this review were
undertaken:
. . .the entrepreneur and his function are not difficult to

conceptualize: the defining characteristic is simply the doing
of new things or the doing of things are that already being
done in a new way (innovation). It is but natural, and in
fact it is an advantage, that such a definition does not draw
any sharp line between what is and what is not ‘enterprise.’
400
401
The basic fact remains that any possible tangible measure of en-
trepreneurship or entrepreneurial activity is necessarily imperfect. Re-
searchers can only hope to provide a proxy for the underlying concept.
Indeed, policies intended to encourage entrepreneurial or small business
activity are just as diverse as the set of available proxies, and those
policies are not necessarily focused on a singular goal of encouraging
innovation or informational spillovers. It is, therefore, counterproductive
to criticize any single measure as less than perfect, unless they are being
sold as something better or different than they are. The best strategy
is to move forward with the data at our disposal, and to ensure that
the chosen proxy is closely linked to the research and/or policy goals
at hand. Rather than hang our hats on a single “best” measure, we
can only hope to surround the empirical question with a multitude of
possible candidates.
Fortunately, researchers who are interested in understanding the
impacts of policy on entrepreneurship or small business activity have
many options from which to choose. In this section, we list several of
the more common options and briefly evaluate each one. Before we get
into the specifics of each measure, we first consider several front-end
questions that must be addressed when selecting one or more indicators
of entrepreneurial or small business activity.
One issue is whether the researcher is interested in the extensive or
intensive margin. The vast majority of the empirical studies reviewed
herein have considered extensive-margin indicators of the mere existence
of entrepreneurial or small business activity. Several more recent studies
have explored intensive-margin indicators of the scale or success of the
activity. One’s choice here is obviously dependent on the task at hand,
but our sense is that most of this literature is policy-driven and policy
makers are probably more concerned with the intensive margin. It is
probably better to have a smaller number of more successful enterprises
than a larger number of failures, especially when it comes to evaluating
the effects of pro-entrepreneurship policies.
Another issue is whether one is interested in stock or flow indicators.
While some studies intentionally focus on the counts of entrepreneurs or
small firms, others explore measures of net firm creation or destruction
402 Measuring Entrepreneurship
over time. Both can be useful components of a broader literature on

this topic.
Next, researchers must understand whether their study will be
focused on individual or aggregate decisions. The literature is full of
valuable studies in both of these categories. Those who wish to explore
the micro-level effects of changes in individual tax rates might choose to
exploit one of several available surveys or administrative data sources at
the individual level. Others who are interested in the broader economy-
wide impacts of changes in general tax policies might focus on aggregated
measures. It is critical, of course, to be clear about what is (and is not)
included in the measure at hand. Differences in data definitions and
accuracy can have very important implications for the research.
Beginning with the extensive-margin indicators, many of the earlier
studies described herein focused on one or more indicators of self-
employment activity, viewing it as a substitute for wage-and-salary em-
ployment. Data sources that capture indicators of self-employment status
typically include large-scale labor surveys at the individual level (e.g.,
the Panel Study of Income Dynamics) and published self-employment
rates at the aggregate level (by, for example, the Bureau of Labor
Statistics). While self-employment status is an important measure that
is broadly available across countries and over time, reporting that one
is self-employed does not necessarily imply entrepreneurial effort or suc-
cess. This is an important issue that becomes relevant in understanding
the diversity of results from the empirical literature. We return to this
discussion below.
Other micro-level extensive-margin indicators include the presence
of income from a small business or profession, typically drawn from labor
surveys or Internal Revenue Service tax return data. One advantage
of these sources over survey-based self-employment status is that the
presence of income from the business can help separate active businesses
from dormant ones. Of course, a common criticism is that the presence
of income does not necessarily imply the occurrence of entrepreneurial
activity. The most cited example is the academic researcher who receives
an honorarium for a lecture and reports that on a small business tax
return. Another problem is that the lack of third-party reporting might
403
cause some true entrepreneurs to understate or not report their income,

thus excluding them from the measure.
To be sure, the same sources that indicate the existence of en-
trepreneurial or small business income often provide useful intensive-
margin indicators of the amount of income. On the surface, the income
from the enterprise can be a useful indicator of the scale and success
of the business. However, different revenue and expenditure patterns
across industries can yield divergent levels of success for similar levels of
gross or net income. Low or negative profits might also be observed early
in the lifecycle of ventures that are truly innovative and entrepreneurial.
More aggregate-level extensive-margin indicators include the usual
counts of small firms or establishments within an area or time period.
These data are typically available in size categories, requiring the re-
searcher to make a decision about which categories to include as “small.”
Studies can then explore both the counts of firms or establishments
in those categories and also the share of all firms or establishments in
those categories. The most common source for these types of indicators
is the U.S. Census Bureau’s Business Dynamics Statistics (BDS) data,
created from the Longitudinal Business Database (LBD).1 Each BDS
enterprise is considered to be a single firm, and firm-level information
is aggregated using establishment-level information from an underly-
ing survey. The number of small firm establishments is defined as the
number of physical business locations owned by a single enterprise.
Many researchers using aggregate data choose to accept the U.S. Small
Business Administration’s definition of “small firms” as those with fewer
than 500 employees.
An intensive-margin corollary within the small firm/establishment
data from BDS are the annual measures of small firm/establishment
birth and death rates. These concepts can be explored in counts or
percentages. Small firm/establishment birth and death are based on
firm-level employment, defined as the number of full- and part-time
workers employed by a firm in March of that year’s survey. Entry and
exit are defined as going from or to zero employment between two survey
1
For more details, see United States Census Bureau, Business Dynamics
Statistics: Methodology, available at https://www.census.gov/programs-surveys/bds/
documentation/methodology.html.
years, respectively. One major advantage is that the data are available
for sub-national geographies and for a long period of time, at least for
the U.S.
It is important to recognize that small firm establishment births
and deaths do not necessarily represent new firm formation or existing
firm failure. Business entities can move between size categories and
legal forms (e.g., from non-corporate proprietorships to corporations).
The IRS Statistics of Income Integrated Business Data is perhaps the
only large-scale data source that enables the examination of businesses
across all legal forms (sole proprietors, partnerships, and corporations
of varying forms).2 Examples of measures from this source include the
number of sole proprietorships or partnerships, either in levels or as a
percentage of all businesses. Bruce and Glenn (2016) also explore the
percentages of gross and net income across each of the major legal form
categories. It is important to recognize that small firms, those most
often associated with entrepreneurship in the literature, distribute rather
broadly across all legal forms, including corporations. Additionally, as
with most measures, many forms that attract larger numbers of smaller
firms include some that might not be widely viewed as entrepreneurial.
The empirical literature has recently turned towards the considera-
tion of several widely-available intensive-margin indicators. These in-
clude more continuous measures of the scale or success of entrepreneurial
activity. Examples include self-employment (or small business) income
and employment, and variants on both. These can be expressed simply
in dollar terms at the individual or aggregate levels, or as shares of
totals within a particular geography and/or point in time. For most of
the available extensive-margin indicators discussed above, there is at
least one intensive-margin indicator. As noted, the presence or level of
income or employment does not necessarily indicate success.
Several recent studies have explored intensive-margin indicators
from the Bureau of Economic Analysis’ National Income and Product
Accounts. One example is nonfarm proprietors’ income (pre-tax income
earned by sole proprietorships, partnerships, and other nonfarm and
2
For more details, see http://www.irs.gov/uac/SOI-Tax-Stats-Integrated-
Business-Data.
405
25% 100
90
20% 80
70
15% 60
50
10% 40
30
5% 20
10
0% 0
% of Individual Income Tax Self-Employment Rate Top Marginal Tax

Returns with Business/ Rate (Right Axis)
Profession Income
Figure 2.1: Self-employment rates, the share of individual tax returns with small
business income, and maximum marginal individual income tax rates, 1950–2018.
non-corporate businesses) as a share of total personal income.3 Bruce

et al. (2015) and Bruce and Glenn (2016) examine that in addition to a
similar measure of nonfarm proprietors’ employment.
A look at the most recent data for the U.S. is helpful in under-
standing the lack of obvious consensus from the empirical literature to
date. Figure 2.1 plots what are perhaps the three most commonly-used
indicators in the time series literature. Entrepreneurial indicators in this
figure illustrate the total self-employment rate and the percentage of
3
For more details, see the Bureau of Economic Analysis NIPA Handbook
(especially Chapter 11: Nonfarm Proprietors’ Income) at http://www.bea.gov/
methodologies/index.htm#national_meth.
6000 65000
60000
5500
55000
5000
50000
4500
45000
4000
40000
3500
35000
3000 30000
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Number of Small Firm Number of Small Firms Small Firm Total
Establishments (1,000s) Employment (1,000s,
(1,000s) Right Axis)
Figure 2.2: Small firm, establishments, and employment, 1978–2014.
U.S. federal individual income tax returns with income from a business
or profession, partnership, or small business corporation. The maximum
U.S. federal statutory marginal individual income tax rate is also pro-
vided. The divergence between the two entrepreneurship indicators is
apparent and interesting. While the self-employment rate has trended
downward along with the top marginal tax rate, the percentage of tax
returns with small business income has grown substantially.
It is clear from this figure that studies of the impacts of tax rates
on entrepreneurship or self-employment could easily yield contradictory
results depending on the selected outcome measure. We note that the
figure implies that lower tax rates reduce self-employment, consistent
with theoretical predictions that lower rates reduce the attractiveness
407
750
700
650
600
550
500
450
400
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Small Firm E stablishment E ntry Small Firm E stablishment E xit
(1,000s) (1,000s)
Figure 2.3: Small firm establishment entry and exit, 1978–2014.
of entrepreneurship by reducing the value of loss offsets. Conversely,

business income reporting increases with lower rates, consistent with the
idea that reporting compliance is higher when the gains to avoidance
or evasion are lower. Although this figure illustrates diverging trends
for U.S. data, differences in the effects of public policies for alternative
measures of entrepreneurship have also been shown for international
data (Chowdhury et al., 2015).
Three additional entrepreneurship indicators from the Business
Dynamics Statistics are plotted in Figure 2.2. Shown are numbers of
small firms with fewer than 500 employees, and the establishments
(left axis) and employment (right axis) within those firms. Unlike the
diverging measures in Figure 2.1, all three BDS measures have gen-
erally trended upward with cyclical interruptions during recessionary
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
2010
2011
2012
2013
2014
2015
2016
Nonfarm Proprietors' E mployment Nonfarm Proprietors' Income as a
as a % of T otal Nonfarm % of Personal I ncome
E mployment
Figure 2.4: Nonfarm proprietors’ employment and income, 1970–2016.
periods. Interestingly, the intensive-margin employment series generally

paralleled the extensive-margin firm and establishment counts.
The simple counts in Figure 2.2 mask the substantial volatility in
small business start-up and survival. Getting closer to the dynamics
of small business activity, Figure 2.3 shows small firm establishment
entry and exit rates from the BDS data. The entry rate exceeds the
exit rate in all but a few years in the historical data (thus the generally
increasing upward trend in the number of small firm establishments in
Figure 2.2). It is interesting that both entries and exits have trended
generally upward since the late 1970s. Also worth noting is the sharp
409
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Non-Farm Sole Props Partnerships Corporations
Figure 2.5: Distribution of business tax returns by return type, 1980–2013.
drop-off in entries during the Great Recession, corresponding to a similar

but slightly later reduction in exits.
Turning back to the intensive margin, Figure 2.4 provides historical
trends in employment and income among non-farm sole proprietorships,
both as a share of total non-farm employment and income, respectively.
These two series have received significant attention in recent empirical
literature. The upward trend in the employment share is consistent with
most of the other indicators of entrepreneurial activity presented above.
The generally flat trend in non-farm proprietors’ income as a share of
total personal income is perhaps most puzzling, and again highlights the
possibility that alternative measures of entrepreneurial activity might
move in opposite directions relative to tax rate changes.
Figures 2.5, 2.6, and 2.7 present key data on business tax returns
drawn from the IRS SOI Integrated Business Data. What is most
unique about this source is that all businesses are included regardless
of size or legal form. Figure 2.5 reveals, unsurprisingly, that the vast
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Figure 2.6: Distribution of business gross income by return type, 1980–2013.
majority of business tax returns are pass-through entities (non-farm sole

proprietorships and partnerships) filing within the individual tax system.
Only about one in five are corporate businesses, and the corporate share
has fallen somewhat since 1980. This data supports a focus on the
effects of the personal income tax on entrepreneurial activity. The story
is quite different when looking at the distribution of total business
income in Figure 2.6. Specifically, while the corporate share of gross
business returns has fallen substantially over time, corporate entities
still report in excess of 80 percent of all business income on tax returns,
suggesting that the corporate income tax is also highly relevant for
business-related tax policy interventions. We note that pass-through
entities, and especially partnerships, are reporting a steadily larger
share of business income since the mid-1990s, again highlighting the
relevance of the personal income tax. While the distribution of net
(i.e., taxable) business income in Figure 2.7 is somewhat similar, it is
striking that non-farm sole proprietorships report a much larger share
of net income than gross income (even though that share of net income
has fallen significantly in recent years). The partnership share of net
411
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
-10%
Figure 2.7: Distribution of business net income by return type, 1980–2013.
business income is large and rising over time. This figure illustrates
that non-corporate filers report a disproportionate share of taxable net
business income, which is likely a product of factors that might include
profitability, but might also reflect sophistication in applying long-term
financial planning and tax avoidance activities.
3
Measuring Tax Policy
The empirical literature on taxes and entrepreneurship has grown far

beyond its origin of focusing on national-level tax rates within individual
income tax systems. To be sure, small businesses face numerous taxes
at all levels of government, and it is not at all clear that one is more
important than or impactful than any other. Before discussing the
variety of taxes that have entered this literature, we first discuss a few
important decision points confronted by any empirical study. Decisions
are typically driven by researcher and/or policy interest, and are almost
always limited by data content and availability.
Efforts to understand the relationships between taxes and small
business activity must first address the optimal level of analysis, both in
terms of the unit of observation and the level of detail for tax features.
While more recent publicly-available data has permitted individual-
level analysis with actual individual tax rates, one might argue that
aggregated analyses using statutory tax rates or other features are more
important as a result of their visibility. As one example, an individual
entrepreneur might not actually know their current marginal income
tax rate, but they might react to a highly-publicized change in the
412
413
statutory tax rate structure. The important thing to remember is that

both of these could yield worthwhile research.
Another important and related issue is whether it is marginal or
average, or perhaps even effective, tax rates that matter most for
entrepreneurial decisions. If small business formation is a marginal
decision made with the last unit of time or labor, then marginal tax
rates might be more appropriate. Alternatively, average or effective tax
rates might be better in all-or-nothing decisions between two states
of the world. Even when a decision to focus on marginal tax rates is
compelling, it is not clear whether a taxpayer’s statutory (i.e., bracket)
marginal rate is better than something closer to an effective marginal
tax rate, calculated as the change in taxes due when income changes by
some fixed amount.
It is possible that potential or active entrepreneurs might change
their behavior in response to the entire menu of tax rates within a tax
system. Even within a graduated-rate (i.e., progressive) individual in-
come tax, longer-range planning could and perhaps should be done with
an eye towards the entire schedule or graduated tax rates. Capturing
the overall progressivity of any particular tax or the entire tax system
is not a trivial exercise. Prior efforts have included overall average tax
rates as well as minimum and maximum tax rates. Others have included
tax rates at different specified income levels as a way to characterize the
broader degree of progressivity. These approaches are obviously better
for more aggregated studies. Individual-level studies might consider
controlling for a taxpayer’s current marginal rate defined for a small
change in income, as well as an alternative marginal rate defined over a
larger change in income.
The impact of tax policies on small business activity surely extends
beyond matters of tax rates. Starting with the income tax, such features
as the taxability of certain business expenses might be even more
important than the tax rates themselves. One example would be the
taxability of employer-provided health insurance for the entrepreneur
and his/her employees, for which the tax rules have changed over time
in the U.S. Depreciation rules are also frequently-used by policy makers
as ways to provide tax relief for small businesses without necessarily
reducing tax rates. Expanding bonus depreciation or expensing limits
414 Measuring Tax Policy
can provide important benefits to new and existing small firms, yet only
a few studies have considered them.
At the subnational level, state and local governments are notorious
for providing a menu of tax relief in the forms of outright subsidies, tax
abatements, and a seemingly endless string of other tax and non-tax
incentive programs. These are often deliberately designed to have an
impact on the number and scale of small business enterprises, and should
be considered by researchers in this area. That being said, gathering
systematic data on the existence and use of these provisions has proven
to be very difficult.
While the vast majority of studies documented in this review have
focused on individual income taxes at the national level, a number
of them have explored a variety of other taxes and other levels of
government. We discuss each of the major tax areas here, focusing on
their potential impact on entrepreneurial activity. We return to a review
of the empirical findings on each tax below.
3.1 Personal Income Taxes
Most empirical studies have focused on the personal or individual

income tax because the majority of new and small businesses are non-
corporate entities who pay their business taxes through the individual
code. Importantly for this literature, individual income taxes often fea-
ture progressive marginal rates as well as taxation on combined income
across sources. Under typical circumstances, this permits business losses
to be used to offset other sources of income. Combined with the gradu-
ated marginal rates, this compresses the distribution of after-tax income
and provides potentially-valuable insurance benefits to small business
owners (Domar and Musgrave, 1944). This could lead to increased levels
of small business investment, even though higher marginal tax rates
reduce the after-tax return to effort.
Incentives for legal tax avoidance or illegal tax evasion are wrapped
up in the individual income tax discussion, as higher tax rates represent
higher rewards to both (Bruce, 2000). Indeed, the act of starting a
small business or becoming self-employed could represent tax avoid-
ance activity for wage workers (Blau, 1987; Joulfaian and Rider, 1998;
3.2. Corporate Income Taxes 415
Long, 1982a,b; Robson and Wren, 1999). Marginal tax rate increases
can create additional behavioral responses on the intensive margin
among existing small businesses. Saez (2010) provided interesting recent
evidence that certain taxpayers were increasing reported small business
income in order to maximize Earned Income Tax Credits.
3.2 Corporate Income Taxes
To be sure, many small businesses opt to incorporate in order to enjoy

potentially lower marginal tax rates, more aggressive deduction oppor-
tunities, and certainly the benefits of limited liability protection. The
relative marginal tax rates from personal and corporate tax systems are
relevant both on the start-up and incorporation margins (Cullen and
Gordon, 2007; Feldstein and Slemrod, 1980; Gordon, 1998; Schuetze
and Bruce, 2004). The relative tax rates can certainly impact organiza-
tional form decisions (Luna and Murray, 2010). They can also provide
additional insurance benefits, especially when corporate tax rates fall
below individual income tax rates.
While the US tax system has typically featured higher marginal
tax rates on individual income than on corporate income, there was
a period of time during the 1980s when the top marginal individual
income tax rate was lower than the top marginal corporate income
tax rate. This provides a useful opportunity to identify the impacts of
the relative tax rates on a variety of small business outcomes, notably
incorporation. In general, small businesses facing losses might choose
not to incorporate in order to use the loss to offset other income under
the individual income tax system (Cullen and Gordon, 2007). Successful
businesses would simply use their organizational form decision to opt
into the lower-tax-rate structure (Gordon and Slemrod, 2000).
Several state-level studies have explored corporate income tax rates
and features, suggesting that the corporate tax rate could function as a
visible signal of the general tax burden on businesses of varying sizes
and legal forms (Bruce and Deskins, 2012). The top corporate rate
can also be relevant in a forward-looking context. In other words, even
though most new small businesses will not likely face the corporate
416 Measuring Tax Policy
income tax or even the highest marginal tax rate, most probably hope
they will at some point in the future.
Other studies have explored the importance of other important
features of state-level corporate income tax systems, such as sales factor
weights in the formulas used to apportion multi-state firms’ taxable
income to the various states (Bruce and Deskins, 2012; Bruce et al.,
2019; Bruce et al., 2015). While most state-level corporate income taxes
initially used a traditional three-factor weight with equal weight on sales,
payroll, and property, recent years have seen a gradual shift toward
higher weights on sales and lower weights on the other two factors. This
is deliberately intended to shift the corporate tax burden away from
larger in-state firms onto out-of-state firms (Luna and Murray, 2010).
3.3 Sales Taxes
While sales taxes are perhaps intended as taxes on personal consumption,

the reality is that businesses bear a significant share of the sales tax
burden. Business purchases are often taxable unless they are purchases
for resale or component parts in a manufacturing process. Ring (1989,
1999) has shown that businesses might bear as much as 40 percent of
the total state and local sales tax burden. It stands to reason, then,
that state sales tax rates and base definitions could have important
impacts on small business outcomes of interest. Impacts are likely to
be most significant in more competitive industries in which businesses
have limited ability to pass the sales tax burden on to their consumers
in the form of higher prices for their goods and services (Bruce et al.,
2015).
3.4 Other Taxes
In addition to federal taxes on individual and corporate income, sev-

eral studies have explored other features of national-level income taxes
such as payroll taxes (Bruce, 2000, 2002; Gurley-Calvez and Bruce,
2008, 2013; Moore, 1983), capital gains taxes (Bruce and Mohsin,
2006), depreciation rules (Bruce et al., 2014; Heim and Lurie, 2014;
House and Shapiro, 2008), health insurance deductibility rules (Gumus
3.4. Other Taxes 417
and Regan, 2015; Gurley-Calvez, 2011; Heim and Lurie, 2010, 2014),
estate, inheritance, and gift taxes (Burman et al., 2018; Cagetti and De
Nardi, 2009; Kreft and Sobel, 2005; Yakovlev and Davies, 2014), research
and development tax credits (Fazio et al., 2019), and business-related
regulations (Crum and Gohmann, 2016; Klapper et al., 2006).
4
Common Problems with Empirical Analysis of
Taxes and Small Business Activity
Researchers have encountered a variety of problems with both data and

estimation throughout the history of this literature, and it is important
to briefly discuss those issues before summarizing the findings. In terms
of data, as alluded to above, it has often been very difficult to obtain
useful data on both entrepreneurship and tax policy. Researchers often
approach the question with a particular definition of entrepreneurship
or small business activity in mind, but available proxies require compro-
mises in virtually every study. While we have better data now than ever
before, the fact remains that all measures of small business activity are,
in some sense, proxies for what researchers typically have in mind. This
can have important implications for empirical analysis, especially if one
is worried about proxy bias or more traditional sorts of measurement
error.
As one example, survey responses to self-employment status have
figured prominently in the literature, but responses are rarely, if ever, au-
dited for accuracy. One can easily respond that they are self-employment
when in fact they are unemployed and/or discouraged about the labor
market. More recent studies have turned to verifiable measures of en-
trepreneurial activity, such as the presence of small business income
418
419
on individual tax returns. While those measures are inherently more

accurate, audit rates are very low and non-compliance is known to be a
problem. Taxpayers can easily over-state expenses or understate income
in order to reduce their tax burden making it unclear whether and to
what extent tax-based measures capture real entrepreneurial activity or
taxpayer behavior.
Conditional on access to useful data, time series and longitudinal
studies must consider the time series properties of their data and
adequately account for pre-existing trends. If self-employment and tax
rates are both trending downward over time, simple econometric models
are likely to find positive correlations in the absence of suitable controls
for autocorrelation or cointegration. We return to these issues in our
discussion of the findings below.
On a similar note, most analyses of the impacts of taxes on en-
trepreneurial activity will at some point need to consider the potential
endogeneity or simultaneity of the tax variables. This is especially impor-
tant in cases when tax rates rise with income, and when policy makers
respond to changes in aggregate income by changing tax rates or other
policies (policy endogeneity). Identifying causal effects of tax policy on
measures of small business activity can be problematic, but is not im-
possible. Carroll et al. (2000a,b, 2001), Bruce (2000, 2002), Gentry and
Hubbard (2000), and Gurley-Calvez and Bruce (2008, 2013) are among
the studies that have used longitudinal data to construct exogenous
instrumental variables. Those studies take advantage of changes in tax
laws and available tax calculators (e.g., TAXSIM) to create measures
of changes in tax rates that are driven by exogenous forces rather than
individual behavior.
5
Summary of Prior Literature
The empirical literature on tax policy and entrepreneurship has ex-

panded considerably in recent decades, due largely to advances in (a)
econometric methodology, (b) data availability, and (c) policy and re-
search interest in the topic. Early studies typically made use of time
series data at the national level, before individual-level cross-sectional
or panel data became widely available. Even as researchers began to
gain access to better data sources over the past few decades, advances
in econometrics made it increasingly possible to cleanly identify effects
of tax rates and other policy variables on entrepreneurial outcomes
of interest. The conventional wisdom from this literature has evolved
substantially as results that were viewed as primarily associative or
correlated began to be replaced by those that were easily defended as
causal.
Our task in this section is to present a broad timeline of the
literature, briefly summarizing earlier studies while spending a bit
more time on the most recent studies. We do this in order to prop-
erly credit the earlier work for opening new doors while emphasizing
the relatively stronger empirical validity in the newer work. We also
highlight studies published since the most recent reviews provided by
420
5.1. Studies Focusing on National Taxes 421
Schuetze and Bruce (2004) and Bruce and Gurley-Calvez (2008). For
convenience, we begin with studies that have focused primarily on
national-level tax policy before turning to a separate discussion of
sub-national tax policy and concluding with international studies.
5.1 Studies Focusing on National Taxes
As summarized by Bruce and Glenn (2016) among others, the simultane-

ous downward trends in self-employment rates and maximum marginal
income tax rates are likely behind some of the earlier time series and
cross-sectional results in the empirical literature. Long (1982a,b), Moore
(1983), Blau (1987), Evans and Leighton (1989), Parker (1996), Robson
(1998), Robson and Wren (1999), and Cullen and Gordon (2007) are
among the studies that have shown a positive relationship between tax
rates and self-employment. We do not wish to cast all of these findings as
definitively spurious, however. Indeed, these results are consistent with
the notion that entrepreneurial activity (including self-employment)
might expand when taxes on wage employment—and thus rewards from
tax evasion or avoidance in self-employment—are higher. Specifically, it
is reasonable to expect income-shielding activity to expand when the
tax rate is higher. None of these studies was able to point specifically
to evasion or avoidance as the primary channel, however, due to the
absence of public data on verifiable tax compliance.
Incidentally, only a few published studies have been able to document
tax evasion activity among the self-employed. Joulfaian and Rider (1998)
used tax return data to show a positive relationship between marginal
tax rates and evasion among the self-employed. Slemrod et al. (2001)
found that Schedule C filers (those with small business income on their
individual income tax return) were more likely to evade taxes. Finally,
as noted earlier, Saez (2010) suggested that Schedule C filers were
over-stating business income in order to maximize Earned Income Tax
Credits. Kuka (2014) confirmed this general finding, but also provided
evidence of important behavioral responses that mirrored the non-self-
employed.
Schuetze (2000) and Cullen and Gordon (2007) explored repeated
cross sections (from the Canadian Surveys of Consumer Finances and
422 Summary of Prior Literature
U.S. Current Population Surveys, and U.S. tax returns, respectively),

and echoed the emerging conventional wisdom that tax rate increases
were positively correlated with small business activity. This theme began
to shift around that same time, however, beginning with Cowling and
Mitchell (1997), who found no statistically significant effects of tax rates
on self-employment in the U.K., and Robson and Wren (1999), who
found divergent impacts of marginal and average tax rates. Time series
work by Fairlie and Meyer (2000), Briscoe et al. (2000), and Bruce and
Mohsin (2006) found no statistically significant relationship. Parker
(2003) echoed this generally with updated cross-sectional evidence.
Similarly, Moore (2002) found no or negative effects of tax increases
in his analysis of repeated cross sections from the U.S. Surveys of
Consumer Finances.
Bruce and Glenn (2016) updated the time series analysis for the
U.S., exploring the potential effects of six different tax variables and
15 different small business activity measures over the period 1950 (or
later, depending on data availability) to 2012. They found only limited
statistical significance, and then typically only on the extensive margin
or in terms of the legal form of the business. Evidence regarding intensive-
margin indicators was mixed.
Despite the obvious advantages of individual-level cross-sectional
data relative to aggregated time series data, cross-sectional data gen-
erally precludes the consideration of the endogeneity of the tax rate
variable(s) in the empirical models as well as the dynamics of small
business formation and survival. An additional shortcoming of the
earlier literature was the inability to separately analyze tax rates on
wage employment and self-employment, which varied in both statutory
and effective terms. The emergence of large-scale longitudinal data has
allowed researchers to tackle these important issues, but it has also
expanded the distribution of empirical results.
Bruce (2000, 2002) and Gentry and Hubbard (2000) brought these
questions to the Panel Study of Income Dynamics, comparing each
individual’s tax rates in wage employment and self-employment and
using statutory variation in tax rate schedules over time to construct
valid tax rate instruments. Bruce (2000) and Gentry and Hubbard
(2000) explored entry into self-employment, while Bruce (2002) focused
5.2. Studies Focusing on Sub-National Taxes 423
on exit from self-employment. Most notable about these studies is

the finding that higher tax rates might actually encourage additional
self-employment activity, consistent with both the insurance aspects of
progressive marginal tax rates with loss offsets as well as the rewards
from tax evasion and avoidance activity.
Carroll et al. (2000a,b; 2001) and Gurley-Calvez and Bruce (2008,
2013) were among the first in this literature to analyze individual-
level longitudinal tax return data, also using statutory changes in
tax rules to construct valid instruments for potentially-endogenous
individual income tax rates. These studies were relatively consistent in
their findings that higher tax rates can have negative impacts on small
business activity as reported on tax returns. For the former group of
studies, those activities included employment, investment, and overall
growth among small firms. For the latter, it was entry into and survival
in small business activity. The two studies by Gurley-Calvez and Bruce
(2008, 2013) showed that across-the-board marginal tax rate cuts could
be good for entry [2013] and survival [2008], at least in terms of small
business activity reported on individual income tax returns.
5.2 Studies Focusing on Sub-National Taxes
Several studies have explored the impacts of sub-national taxes on a

variety of indicators of entrepreneurial activity. Most of these have
harnessed the considerable policy variation inherent in the U.S. state
and local tax system. Like the national-level studies discussed above,
these sub-national studies have yielded inconclusive findings. While
Carlton (1979) was not able to find evidence of a local tax effect on firm
births, Bartik (1989) showed that higher property and corporate taxes
and sales taxes on equipment (but not personal income and general
sales taxes) negatively impacted start-ups. Chen and Williams (1999)
found a positive correlation between per capita sales taxes and business
failure rates in low-tech industries, and a negative correlation between
per capita corporate income taxes and business failure rates in high-tech
industries.
Georgellis and Wall (2006) echoed the recent national-level results
by showing that income tax rates have important non-linear effects
on non-farm sole proprietors as a share of the population. Specifically,

they found a negative effect at lower income levels and a positive effect
at higher income levels, perhaps related to the prior discussion on the
rewards from tax evasion activity at higher tax rates. Garrett and Wall
(2006) found a negative effect of higher corporate tax rates on a similar
measure of entrepreneurial activity as in Georgellis and Wall (2006).
Three more recent studies have progressively added new data, in-
cluding detailed state-level panel data on tax policy features, and new
econometric techniques to arrive at the general conclusion that state
tax policies have limited impact on entrepreneurial activity. The first of
these, Bruce and Deskins (2012), used a 50-state panel of data for 1989
through 2002. Bruce et al. (2015) extended that to 1978 through 2009,
while Bruce et al. (2019) further extended the data to 1978 through
2014.
While Bruce and Deskins (2012) estimated what were then the
typical state-year panel regressions with fixed effects, the two more
recent studies have explored a variety of dynamic panel regressions that
recognize the inherent inertia in state-level tax and entrepreneurship
data. Bruce et al. (2015) also introduced a set of useful intensive-margin
indicators of entrepreneurial activity to the literature derived from
non-farm proprietors’ income and employment data as described above.
Bruce et al. (2019) provide an even more inclusive set of dynamic regres-
sion approaches, recognizing that no single approach can be fool-proof in
this setting. Despite substantial advances in data and methodology, all
of these studies conclude that state tax policies have only isolated and
economically small impacts on a variety of measures of entrepreneurial
activity.
Most recently, researchers have used county-level data and an even
broader range of tax policy measures. Curtis and Decker (2018) use a
panel of 2000–2013 county-level data to estimate the effects of state-
level corporate income, personal income and sales taxes on business
start-ups (i.e., employer firms less than 2 years old). Consistent with the
previous state-level panel studies, the authors find little evidence that
the personal income and sales taxes affect start-up behavior. Consistent
with international findings presented below, the corporate income tax
is negatively related to entrepreneurial activity.
5.2. Studies Focusing on Sub-National Taxes 425
Borchers et al. (2016) follow the state-level fixed effect approach in

Bruce and Deskins (2012) to consider the effects of a broad set of tax
policy factors on growth in small (less than 500 employees) and large
(500 employees or more) number of firms, number of establishments,
employment, and payroll amount. Tax policy measures include statu-
tory rates (corporate income, personal income, and sales tax), specific
elements of the corporate income tax (apportionment factors, combined
reporting, throwback rules), homestead exemptions for bankruptcy fil-
ings, and revenue tax shares (corporate income, personal income, and
sales tax). Results suggest that higher corporate income and sales tax
rates and throwback rules have negative effects for small, but not large,
firm growth.
A related literature uses variation in state-level tax policies to iden-
tify effects on innovation. Although there is certainly innovation in large
firms, entrepreneurship, self-employment, and small businesses are often
linked to innovation and economic growth. Akcigit et al. (2018) esti-
mate the effects of corporate and personal income taxes on innovation
using data on all U.S. patents since 1920 and state-level measures of
tax factors. The authors conclude that higher corporate and personal
taxes reduce innovation. Results are consistent across three different
causal identification strategies, fixed effects estimation, instrumental
variables, and event studies. Mukherjee et al. (2017) also find a nega-
tive relationship between state corporate tax rates and innovation as
measured by patents, research and development spending, and new
product introductions. The authors identify these effects using stag-
gered implementation of tax policy changes and the policy discontinuity
between neighboring counties with different corporate tax rates, but
similar state-level political climates.
Interesting patterns emerge from the literature on U.S. federal and
state-level taxes and entrepreneurship. Panel data estimates of federal
income tax effects differ by data source; survey data estimates indicate
a positive effect while tax-based measures show a negative effect. Future
research might resolve this inconsistency, but it is also possible that
self-employment reported in survey data and captured in tax return
data are fundamentally different measures of entrepreneurship, which
are differentially affected by tax policy. For example, survey data might
better capture real economic activity in self-employment, which increases

with tax rates because of opportunities for avoidance and evasion. This
increase would not necessarily be captured in tax return data that
captures reported self-employment activity. As tax rates increase so
does the cost of accurately reporting positive net income on a tax return.
Estimates of state-level tax policies on entrepreneurship offer few
statistically significant results, with the exception of corporate income
taxes. More specifically, personal income taxes and sales taxes are not
consistently related to measures of entrepreneurship, but corporate
taxes are almost universally negatively related to entrepreneurship
and innovative entrepreneurship. Although the corporate income tax
is not levied on businesses of other organizational forms, we note that
corporate tax policy might affect non-corporate business outcomes if
owners consider tax implications for the lifecycle of their business.
5.3 International Studies
International studies of taxes and entrepreneurship include cross-county

and within-country analyses. We begin by summarizing the within-
country studies, which are most similar in nature to the U.S. studies
discussed in the previous sections.
Again starting with the time series analysis, Stenkula (2012) con-
ducts an analysis of 53 years of Swedish data. Findings suggest a negative
relationship between payroll taxes and self-employment, but no effect
for income and capital gains taxes.
Most within-country studies published in the last two decades use
panel data. These studies include Fölster (2002), who uses two decades of
data for Swedish counties and shows a negative relationship between tax
burden and the ratio of self-employment to total employment. Fölster
(2002) addresses the possibility of simultaneity by using lagged values
of the dependent variable to account for tax affects that spill over
from previous periods. Fossen and Steiner (2009) also find a negative
relationship between tax rates and entrepreneurship using panel data in a
differences-in-differences (DD) framework. The DD approach capitalizes
on two natural German tax reform experiments where only a subset of
filers was eligible for the tax changes based on income level and type
5.3. International Studies 427
of entrepreneurship. The strength of the DD approach is the ability

to control for overall time trends in self-employment using the control
group of unaffected taxpayers. This stands in contrast to panel studies
that cannot fully untangle time and policy effects for policies that apply
across taxpayers as of a particular point in time.
Bacher and Brülhart (2013) expand the set of tax policy factors
beyond rates or burden by also including analyses of tax complexity
and progressivity. The authors use a panel of Swiss jurisdiction-level
data to estimate fixed effects specifications. Results show that tax rates
and complexity are negatively related to firm birth counts. Progressivity
increases firm birth counts, consistent with theoretical predictions of
the insurance effect created by progressive taxation. Ferede (2013) also
addresses the effects of progressivity using a long panel (1979–2006)
of data for Canadian provinces. In contrast to Bacher and Brülhart
(2013), Ferede (2013) finds that progressivity is negatively related to self-
employment using fixed effects estimation. Wen and Gordon (2014) also
estimate a negative relationship between the progressivity (convexity) of
the marginal income tax rates using a 1999–2005 panel of individual-level
Canadian data.
Bosch and de Boer (2019) use a panel of household-level data from
the Netherlands to identify the effects of taxes on self-employment
by capitalizing on tax reforms that had differential effects on self-
employment and wage and salary income. The authors employ a fixed
effects instrumental variables estimation to address endogeneity while
estimating effects on self-employment income and the choice to be
self-employed. Results suggest effects on the intensive margin. Self-
employment income is more sensitive to tax changes than wage and
salary income. However, the authors find no evidence that changes in
the personal income tax rate affect the choice to become self-employed.
Hansson (2012) also uses panel data, but employs a random effects
estimation strategy to assess the relationship between tax rates and
self-employment. He addresses tax rate endogeneity in individual tax
return data from Sweden using synthetic tax rates similar to Bruce
(2000). Results show a negative relationship between marginal and
average personal income tax rates and self-employment.
International studies have also begun using dynamic panel data

techniques to address the relationship between taxes and entrepreneur-
ship. Ferede (2019) shows that increases in the top personal income tax
rate reduce entrepreneurial entry and the number of employer firms in
a panel of data for Canadian provinces.
In addition to the within-country estimates, a number of studies use
cross-country data to assess the effects of tax policy on entrepreneurship.
We begin our discussion with Fölster (2002), who uses a country-level
aggregate measure of tax burden (taxes as a share of GDP). Results
from Fölster (2002) demonstrate a negative correlation between taxes
and self-employment using country-level data for OECD countries.
Several studies focus specifically on the corporate income tax and
use various measures of entrepreneurship (Block, 2016; Da Rin et al.,
2011; Darnihamedani et al., 2018; Klapper et al., 2006). Klapper et al.
(2006) use cross-sectional data for European countries to estimate a
positive correlation between corporate income tax rates and the ratio of
new firms to total firms for high-entry industries. Da Rin et al. (2011)
address the causal effects of corporate taxes on firm entry measured as
the number of new incorporations. The authors use a seven-year panel
of data for 17 European countries. Corporate tax effects are estimated
using country-level fixed effects and several adjustments to address the
endogeneity of tax measures from multiple sources including unobserved
heterogeneity, feedback, and measurement error. Da Rin et al. (2011)
use an innovative strategy to instrument for tax policy using political
economy variables. Across several robustness tests, Da Rin et al. (2011)
provide convincing evidence of a negative association between corporate
taxation and new incorporations. Most recently, Darnihamedani et al.
(2018) examine corporate and personal income tax effects on innovative
entrepreneurship, where innovative firms are those that offer a new
product or service to consumers. In a panel analysis with country
fixed effects, Darnihamedani et al. (2018) find a negative effect of the
minimum corporate tax rate on innovative entrepreneurship and no
significant effect of the personal income tax.
Going beyond measures of tax rates and tax burden, two recent
studies address the effects of tax progressivity on entrepreneurship
5.3. International Studies 429
(Baliamoune-Lutz, 2015; Baliamoune-Lutz and Garello, 2014). Baliamo-

une-Lutz and Garello (2014) use a panel of European countries from
2000–2008 to estimate country-level effects of tax rates and progressiv-
ity on nascent entrepreneurship, defined as the number of individuals
actively in the process of starting new businesses. They use GMM (first-
differencing) to address unobserved factors and find that more progres-
sivity reduces new entrepreneurial activity. Likewise, Baliamoune-Lutz
(2015) uses similar methods to show a negative relationship between
progressivity and nascent entrepreneurship in OECD countries, but find
no effects of average or marginal tax rates.
Taken together, the within- and cross-county international studies
provide consistent evidence that taxes negatively impact different mea-
sures of entrepreneurship. Specifically, taxes are found to reduce the
share of self-employment in total employment, entrepreneurship mea-
sured as business income meeting a dollar threshold, self-employment,
new incorporations, innovative entrepreneurship, and nascent entre-
preneurship. Studies using panel data find that higher corporate taxes
reduce new and innovative entrepreneurship. Studies of tax progressivity
are also generally negative for within-country and cross-country analyses
with one positive effect estimated in one within-country analysis. Con-
sistent with the U.S. based studies, more recent work with international
data uses panel data with a variety of identification strategies including
fixed effects, differences-in-differences, and instruments.
6
Synthesis and Directions for Future Research
Overall, the most recent literature on taxes and entrepreneurship

suggests a negative relationship between tax rates and measures of
entrepreneurship with the most consistent results from changes in
corporate tax rates. The most recent evidence from the international
literature also points to a negative relationship between progressivity
and complexity and a variety of measures of entrepreneurship. A vital
caveat to these generalizations is reflected in the U.S.-based panel data
studies of federal tax rates. Studies based on survey information yield
consistent positive relationships between taxes and entrepreneurship,
while analyses based on tax return data suggest a negative effect more
consistent with the international literature, which also often uses admin-
istrative data. In the discussion below we outline some key differences
in reporting and measurement across datasets that are likely to impact
results in meaningful ways.
The diversity of results in the empirical literature on taxes and
entrepreneurship is directly attributable to differences in the unit of
observation, the time period and frequency of available data, specific
measures and definitions of tax policies and entrepreneurial activity, the
430
431
geographic context, and of course, econometric methodology. Despite

these differences, a new conventional wisdom appears to be emerging.
First, the chosen measure of entrepreneurial activity is very impor-
tant. For example, we should not necessarily expect changes in tax
rates to have similar effects on self-reported self-employment status
and small business income reported on tax returns. The implications
of information differences across measures are not yet fully understood
as the work to reconcile measures across data sets is in its infancy.
Survey and tax return data represent two of the main data sources
in the literature, but researchers rarely have access to information on
the same firms across these data sources. In a 2016 Internal Revenue
Service working paper, researchers link data from the Kauffman Firm
Survey (KFS) with IRS tax returns to assess the degree of reporting
differences across data sources (Gurley-Calvez et al., 2016b). Of note,
the KFS sampling frame was blind to organizational form meaning that
the survey included sole-proprietorships subject to the personal income
tax as well as pass-through entities (i.e., partnerships and S Corpora-
tions) and corporations. Results suggest differences in reporting across
data sources with higher income reporting in survey data, as might be
expected. Perhaps surprisingly, the authors also find higher expense
reporting in the survey data, which might indicate that business owners’
definitions of expenses include spending that is not allowable or only
partially allowable in IRS reporting.
Given that every available measure of entrepreneurial activity is in-
herently imperfect, future research should be careful to consider multiple
options in order to assess robustness of primary findings and sensitivity
to alternative assumptions. In a perfect world, matched survey and ad-
ministrative data would allow the reconciliation of seemingly-divergent
results from the self-employment and small business income studies.
Results from the KFS-IRS matched data file offer some preliminary
insights into the research implications of measures available in survey
data and tax records. Gurley-Calvez et al. (2016a) examine business
survival using KFS and tax-based measures of firm exit or closure. In
the analysis, exit was defined as having an observation in previous
period, but not in the current period for both datasets. The KFS of-
fers a further measure of firm closure, where survey personnel made
432 Synthesis and Directions for Future Research
additional efforts to contact firms with an observed exit to assess if the

business was closed or if the missing observation simply indicated survey
attrition, not firm closure. The authors find that survey-based measures,
particularly measures of firm closure, are much more closely tied to
owner demographics. Exit measures from the tax data are associated
with measures of firm credit scores and business performance.
These differences are critically important if decision makers aim to
develop policies that support new business survival. The survey results
suggest policies targeting particular groups based on gender and age,
whereas results from the tax data suggest that exits are largely driven by
firm financial health and efforts are better spent strengthening financial
indicators such as credit scores.
In addition to the possibility that the same measures such as revenue,
profit, and firm exit are reported differently across data sources, there
is the obvious issue that data sources often contain different measures
of entrepreneurship. The usefulness of alternative measures such as
self-employment, business ownership, business ownership with active
management, incorporated business, nascent business, and innovative
business capture different ideas and are likely to be appropriate for
different research questions. However, differences across measures are
often not explicitly acknowledged in broader discussions of how taxes
affect business outcomes.
One interesting example of relevant state-level tax policy is the
Kansas tax experiment. Signed into law in May 2012, one of the main
provisions of the tax experiment was the elimination of state income tax
on pass-through business income. Although the reform was enacted at a
time when published studies suggested a negative relationship between
personal income taxes and self-employment, the literature included
little to suggest that targeting pass through income would generate the
large increases in economic activity predicted by pro-reform supporters
(Hobson et al., 2017). Sharp revenue declines and subsequent academic
studies confirm that the pass through exemption increased avoidance
through income and effort shifting, but made little impact on real
economic activity (DeBacker et al., 2018, 2019). In this case, and many
other policy contexts, fully informed decisions require clarity over how
tax policy is measured, what types of entities are impacted, and whether
433
these impacts are expected for reporting activity, real economic activity,
or both.
Another key area of consideration is whether changes in tax rates are
expected to impact extensive margin outcomes, such as the number of
entrepreneurs, share of entrepreneurs in total employment, or business
survival and/or intensive margins such as business growth, employment,
or capital investment. It is certainly possible that targeted tax cuts could
have larger impacts on the start-up or existence of a new small business
than on the success of that business (e.g., income or employment). The
latest research suggests that extensive-margin impacts are larger than
the more policy-relevant intensive-margin impacts.
Future research should also continue to make efforts to better identify
causal effects of tax policy on entrepreneurial activity. Ongoing changes
in national, state, and local tax policies can be used to construct
natural experiments, perhaps making use of regression discontinuity
and/or difference-in-differences approaches to identification. Analyses
of tax competition and other regional effects should also take advantage
of the tools of spatial econometrics. Empirical analysis should also
continue to build upon recent efforts to explore the importance of
tax code complexity and administrative burden on small businesses.
Indeed, a greater understanding of these important impacts could
be instrumental in understanding the diversity and evolution of the
empirical results from the literature described herein.
All of these suggestions hinge on continuing improvements in the
quality and availability of data for research purposes. We look forward
to continuing to follow this literature as new and better administrative
and survey data sources become available.
Acknowledgements
We are grateful to Jamie Neville and Caroline Wikman for invaluable

research assistance. We also thank, without implication, the follow-
ing colleagues who have co-authored many of the studies discussed
in this review: John Deskins, Elizabeth Glass, Beth Glenn, Matthew
Harris, Xiaowen Liu, Mohammed Mohsin, Matthew Murray, and Herbert
Schuetze.
434
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Taxes and Entrepreneurship: A Literature Review and Research Agenda

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Foundations and Trends® in Entrepreneurship

Taxes and Entrepreneurship:

2 Measuring Entrepreneurship 400

3 Measuring Tax Policy 412

4 Common Problems with Empirical Analysis of Taxes

5 Summary of Prior Literature 420

6 Synthesis and Directions for Future Research 430

Medical Center, Kansas City, KS 66160, USA; tgurley-calvez@kumc.edu

Tennessee, Knoxville, TN 37996, USA; anorwoo1@utk.edu

positive relationship between tax rates and small business ac-

The potential impacts of tax policies on entrepreneurial activity have

Additionally, the traditional income tax structure provides greater op-

(Goode, 1949). Business purchases often convey consumption benefits

strengths and weaknesses of measures of stocks vs. flows, individual vs.

Empirical studies of the effects of taxation on entrepreneurship or small

. . .the entrepreneur and his function are not difficult to

over time. Both can be useful components of a broader literature on

cause some true entrepreneurs to understate or not report their income,

% of Individual Income Tax Self-Employment Rate Top Marginal Tax

non-corporate businesses) as a share of total personal income.3 Bruce

Figure 2.2: Small firm, establishments, and employment, 1978–2014.

Figure 2.3: Small firm establishment entry and exit, 1978–2014.

of entrepreneurship by reducing the value of loss offsets. Conversely,

Figure 2.4: Nonfarm proprietors’ employment and income, 1970–2016.

periods. Interestingly, the intensive-margin employment series generally

Non-Farm Sole Props Partnerships Corporations

Figure 2.5: Distribution of business tax returns by return type, 1980–2013.

drop-off in entries during the Great Recession, corresponding to a similar

Non-Farm Sole Props Partnerships Corporations

Figure 2.6: Distribution of business gross income by return type, 1980–2013.

majority of business tax returns are pass-through entities (non-farm sole

Non-Farm Sole Props Partnerships Corporations

Figure 2.7: Distribution of business net income by return type, 1980–2013.

The empirical literature on taxes and entrepreneurship has grown far

statutory tax rate structure. The important thing to remember is that

3.1 Personal Income Taxes

Most empirical studies have focused on the personal or individual

3.2 Corporate Income Taxes

To be sure, many small businesses opt to incorporate in order to enjoy

3.3 Sales Taxes

While sales taxes are perhaps intended as taxes on personal consumption,

3.4 Other Taxes

In addition to federal taxes on individual and corporate income, sev-

Researchers have encountered a variety of problems with both data and

on individual tax returns. While those measures are inherently more

The empirical literature on tax policy and entrepreneurship has ex-

5.1 Studies Focusing on National Taxes

As summarized by Bruce and Glenn (2016) among others, the simultane-

U.S. Current Population Surveys, and U.S. tax returns, respectively),

on exit from self-employment. Most notable about these studies is

5.2 Studies Focusing on Sub-National Taxes

Several studies have explored the impacts of sub-national taxes on a

on non-farm sole proprietors as a share of the population. Specifically,

Borchers et al. (2016) follow the state-level fixed effect approach in

better capture real economic activity in self-employment, which increases

5.3 International Studies

International studies of taxes and entrepreneurship include cross-county

of entrepreneurship. The strength of the DD approach is the ability

International studies have also begun using dynamic panel data

(Baliamoune-Lutz, 2015; Baliamoune-Lutz and Garello, 2014). Baliamo-

Overall, the most recent literature on taxes and entrepreneurship

geographic context, and of course, econometric methodology. Despite

additional efforts to contact firms with an observed exit to assess if the