Income Taxation and Business Incorporation: Evidence from the Early Twentieth Century
If the corporate income tax is set at a different rate from non-corporate in-come tax, it can play an important role in a firm’s choice of organizational form. The impact and interdependency of income tax incentives are crucial factors in the formation of designing efficient tax policies. In this paper I exploit the variation in income taxes across U.S. states in the early twentieth century to estimate these sensitivities. Potential endogeneity of state taxes is addressed using an IV approach. The results demonstrate that the relative taxation of corporate to personal income has a significant impact on the corporate share of economic activities. On average, a one percent increase in corporate taxes is associated with 0.2-0.3 percent decreases the corporate share of economic activities, whereas a one per-cent increase in personal taxes raises the corporate share of economic activities by 0.5-0.6 percent.
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