Tax Policy and Entrepreneurship

Small businesses and the entrepreneurial spirit are among the driving forces in economic growth and development in the United States. The US governments (both federal and state) have long been aware of the importance of entrepreneurship, and many policies are directed toward helping small businesses. However, whether such policies give rise to expected behavioral responses from small businesses remains inconclusive. This dissertation looks into the behavioral response of self-employed filers to individual income tax and the impact of state and federal tax policies on entrepreneurship. In the first chapter, we examine taxpayers’ behavioral response to the Alternative Minimum Tax (AMT). We find strong evidence that taxpayers, especially self-employed individuals, appear to manipulate their incomes to avoid the AMT. We also find suggestive evidence that the notch created by the AMT generates both a real response and an evasion response. These results have important policy implications for the AMT design and for the evaluation of the welfare loss from taxation of small businesses. The second chapter examines the effect of state tax policies on entrepreneurial activity. This paper contributes to the literature in several important ways: first, we explore dynamic specifications to capture inherent time trends among entrepreneurial performance. Second, we consider a number of intensive-margin measures of state nonfarm proprietors’ success. Our paper is the first to use nonfarm proprietors’ income as a direct measure of entrepreneurial success at the state level. We investigate several measures of small business performance derived from nonfarm proprietors’ income and employment data. Third, we extend the earlier research by including a longer panel (1978-2009) of state data. Despite these innovations, our empirical results echo the recent studies in this area and suggest that most of the highly-visible state tax policies do not have statistically significant impacts on entrepreneurial performance. The last chapter uses time series analysis to explore the effect of federal tax policies on entrepreneurial performance and whether the effect is heterogeneous across different stages of the business cycle. We do not find that tax policy affects the small businesses sector differently between economic ups and downs.