Federal Tax Policy and Small Business

Abstract

Do entrepreneurs need tax reform? This chapter presents a critical evaluation of the desirability of tax incentives for small businesses. We discuss measurement issues in identifying entrepreneurs in publicly-available data and then describe recent trends in several measures gleaned from tax data. Entrepreneurial activity is on the rise as evidenced by a growing share of non-corporate entities among business tax returns. Small businesses represent a disproportional share of taxable profits when compared to their share of total business receipts. We then turn to a discussion of the current tax treatment of entrepreneurs, followed by a brief overview of recent economic research on entrepreneurial sensitivity to tax policies. Economic theory suggests that taxes can have ambiguous effects on transitions into or out of entrepreneurial activity, which leaves the determination of overall effects to empirical analysis. This leads us to a presentation of our recent analysis of a twelve-year panel of U.S. federal individual income tax returns to examine the effects of federal income and payroll taxes and state income taxes on entrepreneurial activity. Our focus in this new analysis is on the effects of tax rates on individual transitions into or out of some form of entrepreneurial activity.