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Owner-Level Taxes and Business Activity

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  • Henrekson, Magnus

    (Research Institute of Industrial Economics (IFN))

  • Sanandaji, Tino

    (Institute for Economic and Business History Research (EHFF))

Abstract

In some classes of models, taxes at the owner level are "neutral" and have no effect on firm activity. However, this tax neutrality is sensitive to assumptions and no longer holds in more complex models. We review recent research that incorporates greater complexity in studying the link between taxes and business activity - particularly entrepreneurship. Dividend taxes on owners of large firms affect firm activity in models that include agency conflicts between owners and managers. Similarly, after incorporating entrepreneurs’ occupational choice into the model, taxes are no longer neutral. By forsaking lucrative alternative careers, skilled entrepreneurs tend to have high opportunity costs, which make the choice of attempting to start a business of first order importance. Moreover, in models where it is assumed that capital flows across borders without cost, taxes on domestic business owners do not alter business activity because foreign capital seamlessly compensates for tax-induced declines in investments. This theoretical notion is contradicted by the strong "home bias" observed in business ownership, in particular for small firms and startups without easy access to international capital markets. Recent empirical work has emphasized that taxes have heterogeneous effects on mature firms, entrepreneurial startups, and owner-managed small firms. Lowering dividend taxes on firms with dispersed ownership has been shown to shift capital from mature firms into rapidly growing firms. Moreover, capital gains taxation tends to reduce the number of innovative startups and diminish venture capital activity, while high owner-level taxes encourage small business activity and non-entrepreneurial self-employment because such firms have more opportunities to avoid or evade taxes. To obtain efficient incentives in entrepreneurial startups, contractual terms are required that ex ante guarantee that all providers of critical inputs, especially equity constrained entrepreneurs, are entitled to a share of the resulting capital value firm. Unless properly designed, owner-level taxes prevent such ex ante contracting and thus lower the likelihood of eventual success.

Suggested Citation

  • Henrekson, Magnus & Sanandaji, Tino, 2015. "Owner-Level Taxes and Business Activity," Working Paper Series 1086, Research Institute of Industrial Economics, revised 19 Feb 2016.
  • Handle: RePEc:hhs:iuiwop:1086
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    Cited by:

    1. Dackehag, Margareta & Hansson, Åsa, 2015. "Taxation of Dividend Income and Economic Growth: The Case of Europe," Working Paper Series 1081, Research Institute of Industrial Economics.
    2. Magnus Henrekson & Tino Sanandaji, 2018. "Stock option taxation: a missing piece in European innovation policy?," Small Business Economics, Springer, vol. 51(2), pages 411-424, August.
    3. Henrekson, Magnus & Sanandaji, Tino, 2017. "Schumpeterian Entrepreneurship in Europe Compared to Other Industrialized Regions," Working Paper Series 1170, Research Institute of Industrial Economics, revised 29 Jun 2018.
    4. Lakomaa, Erik & Sanandaji, Tino, 2017. "Integrating community driven care service in European welfare states – nonprofit institutional entrepreneurship as driver for expanding access," SSE Working Paper Series in Economic History 2017:5, Stockholm School of Economics.

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    More about this item

    Keywords

    Business taxation; Capital income taxation; Corporate governance; Entrepreneurship; Institutions; Tax policy;
    All these keywords.

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm
    • L26 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Entrepreneurship

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