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Entrepreneurship and the Theory of Taxation

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  • Henrekson, Magnus

    ()
    (Research Institute of Industrial Economics (IFN))

  • Sanandaji, Tino

    ()
    (University of Chicago)

Abstract

Taxation theory rarely takes entrepreneurship into consideration. We discuss how this omission affects conclusions derived from standard models of capital taxation when applied to entrepreneurial income. Some of the defining features of entrepreneurship often omitted by standard capital taxation theory are incorporated into the analysis. This includes the lack of a well-functioning external market for entrepreneurial effort, limited access to external capital and the complementarities between entrepreneurial effort, entrepre-neurial innovation and capital investment. Because of these constraints, the entrepreneurial project is tied to the individual owner-manager. Unlike the typical passive portfolio investor assumed in cost of capital models the entrepreneur is unable to decouple savings decisions from investment decisions, and due to the comple-mentarities in production makes a joint decision on the supply of effort and capital. The returns from success-ful entrepreneurial ventures thus cannot be readily divided into labor and capital income, in stark contrast to what is assumed in standard taxation theory. When unique attributes of entrepreneurship are taken into account, some major conclusions of capital taxation models no longer hold, including the neutrality of capital taxation in owner-managed firms. These results are particularly important for the Nordic system of dual taxation, the theoretical foundation of which relies on the ability to neatly separate capital income from the labor income of the self-employed.

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Bibliographic Info

Paper provided by Research Institute of Industrial Economics in its series Working Paper Series with number 732.

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Length: 23 pages
Date of creation: 31 Jan 2008
Date of revision: 19 Aug 2009
Publication status: Published as Henrekson, Magnus and Tino Sanandaji, 'Entrepreneurship and the Theory of Taxation' in Small Business Economics, 2011, pages 167-185.
Handle: RePEc:hhs:iuiwop:0732

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Keywords: Capital Income Taxation; Dual Income Taxation; Entrepreneurship; Innovation; Institutions; Labor Supply; New Firm Creation; Optimal Factor Taxes; Taxation; Tax Policy;

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Cited by:
  1. Stenkula, Mikael, 2009. "Taxation and Entrepreneurship in a Welfare State," Working Paper Series 800, Research Institute of Industrial Economics.
  2. Ioana Maria Costea, 2012. "Labour Taxation: Formal And Informal Solutions," "Perspectives of Business Law” Journal, Societatea de Stiinte Juridice si Administrative (Society of Juridical and Administrative Sciences), vol. 1(1), pages 320-331, December.
  3. Sanandaji, Tino & Leeson, Peter, 2013. "Billionaires," Working Papers 2012:18, Swedish Entrepreneurship Forum.
  4. Pontus Braunerhjelm & Johan E. Eklund, 2014. "Taxes, tax administrative burdens and new firm formation," Kyklos, Wiley Blackwell, vol. 67(1), pages 1-11, 02.
  5. Norman Gemmel & Richard Kneller & Danny McGowan & Ismael Sanz, 2013. "Corporate Taxation and Productivity Catch-Up: Evidence from European Firms," Working Papers 13001, Bangor Business School, Prifysgol Bangor University (Cymru / Wales).
  6. Henrekson, Magnus & Sanandaji, Tino, 2013. "Small Business Activity Does not Measure Entrepreneurship," Working Paper Series 959, Research Institute of Industrial Economics, revised 26 Jan 2014.
  7. Haufler, Andreas & Norbäck, Pehr-Johan & Persson, Lars, 2014. "Entrepreneurial innovations and taxation," Journal of Public Economics, Elsevier, vol. 113(C), pages 13-31.

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