Can Tax Reform Spur Entrepreneurship?

Top Tax Rate

From the Goldwater Institute

By Stephen Slivinski

Entrepreneurs are the lifeblood of innovation in our modern economy. They create opportunities for themselves and jobs for others.

It’s certainly a good idea for a state to create an environment that allows as much entrepreneurial activity as possible. In my Goldwater Institute study, Increasing Entrepreneurship is a Key to Lowering Poverty Rates, I show that there’s a strong link between low taxes and entrepreneurship.

The study builds on research published by the U.S. Small Business Administration and authored by University of Tennessee economist Donald Bruce and Creighton University economist John Deskins. They studied how a number of different tax policies affected the level of entrepreneurship between 1989 and 2001. They found that high income taxes and high marginal income tax rates decreased the amount of entrepreneurship in a state. They also discovered that high rates of entrepreneurship are related to declines in the poverty rate.

My study extends the analysis through 2007 and shows that there is a strong the connection between how much entrepreneurship a state enjoys and the state’s general tax burden (sales tax, personal income tax, and corporate income tax) as a percentage of personal income. As you can see in the trendline in this chart, higher tax burdens correspond to lower rates of entrepreneurship.

How a state taxes matters too. States without income taxes have higher average rates of entrepreneurship than those with income taxes. The average entrepreneurship rate in states without an income tax is 21.7 percent, but for states with income taxes it’s 19.6 percent. That two percentage point difference may seem small but it represents at least a couple thousand new entrepreneurs in the average state.

A state that eliminated its income tax would certainly see an increase in the number of entrepreneurs. This shouldn’t be surprising. Most entrepreneurs and small businesses – sole proprietorships and partnerships – pay their business taxes by filing a personal income tax form each year. Getting rid of the income tax is the best way to directly eliminate one of the big barriers to entrepreneurship.

Thousands of Arizonans are living their dream of working for themselves. It is incumbent on policymakers not to stand in the way of those who would like to share in that dream and start their own businesses. By focusing on reforming the tax code, policymakers can help make Arizona a better, more prosperous, and more entrepreneurial place.