Dissertation submitted to the Faculty at the Irving B. Harris Graduate School of Public Policy Studies in Candidacy for the Degree of Doctor of Philosophy
This thesis has three chapters.
In the first chapter, a joint work with Magnus Henrekson, we discuss the taxation of entrepreneurial income. A review of the literature on firm taxation reveals that the economics of entrepreneurship has not sufficiently been taken into consideration. We discuss how this affects conclusions derived from standard models of capital taxation when applied to entrepreneurial income. Some defining features of entrepreneurship important for analyzing the effects of taxation of owner-managed firms are identified. These include the lack of a well-functioning external market for entrepreneurial effort, limited access to external capital and complementarities between entrepreneurial innovation, effort and capital. Due to these constraints, the entrepreneurial project is tied to the individual owner–manager. The entrepreneur is unable to decouple saving decisions from investment decisions, and makes joint decisions on the supply of effort and capital. The return from successful entrepreneurial ventures can therefore not be readily divided into labor and capital income, in deep contrast to what is typically assumed in taxation theory. It is argued that when distinct attributes of entrepreneurship are taken into account, certain conclusions of capital taxation models may no longer hold, including the neutrality of capital taxation in owner-managed firms. Cost of capital formulas derived from the behavior of public firms could underestimate distortions when applied to the investment behavior of entrepreneurial firms. For tax purposes and otherwise, it becomes useful to analyze return to entrepreneurial activity as income of a distinct factor of production. In this context, conceptual issues and the difficulties of measuring entrepreneurial income are discussed.
In the second chapter, which is a joint work with Andrea Asoni, we study the effect of taxation on entrepreneurship, taking into account both the amount of entry and the quality of new ventures. We show that even with risk neutral agents and no tax evasion progressive taxes can increase entrepreneurial entry, while reducing average firm quality. So called “success taxes” increase startup of lower value business ideas by reducing the option value of pursuing better projects. This suggests that the most common measure used in the literature, the likelihood of entry into self-employment, may underestimate the adverse effect of taxation.
In the third chapter I use two newly assembled datasets to demonstrate that the common practice of relying on self-employment to proxy for entrepreneurship often gives to rise to misleading inference. I determine the source of wealth of all billionaires listed on Forbes Magazine's list, identifying 996 individuals in over fifty countries who became rich by founding new firms. Using these individuals to define the per capita rate of entrepreneurship, I show that entrepreneurship rates correlate negatively with self-employment rates. Countries with higher income, lower taxes and less regulation have higher entrepreneurship rates but less self-employment. I attempt to account for these results theoretically using a model where efficient financial markets and a favorable policy environment lead to a better allocation of capital to talent, higher wages, and thereby driving the least productive self-employed individuals to seek employment. This evidence is supplemented with data from a recently administered survey of 12 000 Swedish twins. The survey asks individuals to identify as self-employed or entrepreneurs based on their intentions to innovate and grow their businesses. Whilst the self-employed have lower incomes than employees with similar characteristics, entrepreneurs have higher incomes. These relationships hold both in the cross-section and within family.