Tax Incentives, Minimum Capital Requirements, and the Incorporation Decision

What leads self-employed entrepreneurs to incorporate? I examine how tax incentives interact with the cost of incorporation to answer this question. I exploit the abolition of minimum capital requirements to set up a limited liability company in the Netherlands and compare entrepreneurs that differ in their incentive to incorporate but that are otherwise comparable. After the reform, entrepreneurs whose pre-reform taxable income was closest to a kink where marginal personal income tax rates steeply increase are more likely to start a corporation. Total tax paid by these entrepreneurs is significantly reduced, which suggests they are able to reap the tax benefits of conducting business activity as a corporation. However, there seems to be no significant impact on total business activity – at least in the short term. Finally, there appears to be no significant difference in the probability that business owners own an unincorporated business, which suggests that many entrepreneurs operate a corporation alongside an unincorporated firm.