Capital Taxation and Entrepreneurship

About this event

Policymakers often want to encourage entrepreneurial activity. Commonly, they do this through preferential tax rates on business income, but these come with a substantial tax revenue cost. We develop a dynamic model of business ownership to study the effects of tax policy on small businesses. The model allows for a range of responses - including entry, exit, investment and incorporation to a rich set of tax incentives. We incorporate observed and unobserved heterogeneity to account for the wide variation in the small business population, and exploit tax changes to help identify the costs of switching between legal forms. We show that policies that target specific aspects of small business behaviour, as opposed to broadly applied lower tax rates, increase investment and tax revenue, while reducing income shifting and distortions to the choice of legal form. For example, combining the removal of preferential rates of capital gains tax for business owners with tax deductions for new equity investments increases small business investment by 2.5% and tax revenue from this group by 2.4%.