William M. Gentry of Williams College and R. Glenn Hubbard of Columbia University have released a ground breaking study (this is a site that asks you to purchase the study--hopefully, you get the point from my summary) on the power of tax policy to effect entrepreneurial behavior.
Their study is based on over 50,000 observations. They found that progressive marginal tax rates (rates that increase at higher levels of income) reduce the likelihood that people will engage in entrepreneurial activity. While this makes common sense to many of us, this study provides compelling evidence on how changing our tax policy as proposed by Sen. Kerry could damage or even reverse our current expansion.
"We found robust results that progressive marginal tax rates discourage entry into self-employment and business ownership. Those effects are large: The Omnibus Budget Reconciliation Act of 1993, which raised the top marginal individual income tax rate, was estimated to have reduced the probability of entry into self-employment for upper middle income households by as much as 20 percent. Moreover, those estimated effects were robust to controlling for differences in family structure, spousal income, and measures of transitory income."
The implications of this study cannot be overstated. We face the possibility of a shift of policy at the national level that could result in higher marginal progressive tax rates. Sen. Kerry has made it clear he plans to raise the tax rates of what he calls "the rich". Many of them are entrepreneurs who pay personal taxes on their businesses due to their S-corp, LLC, or partnership status.
Why does tax policy have such an impact? Entrepreneurs who are considering expanding an existing business or starting another may think twice. Each expansion or new business carries risk. And if the rewards are reduced with each new initiative the entrepreneur undertakes, there comes a point when it just isn't worth the risk. So progressive marginal taxes create the most significant disincentives for the very entrepreneurs we want to encourage--those who have already succeeded with other ventures. When I was an entrepreneur in health care we started multiple ventures. We built off our previous success to go into new lines of business and new markets. But each success brought higher taxes and lower after tax returns for those of us taking the risk. We found ourselves thinking twice about deals that we normally would have eagerly pursued as the risk return ratio turned more and more against us.
This site and many others have shown how dependent this economy has become on entrepreneurial growth. Entrepreneurs are not just leading this recovery, they are transforming this economy. The changes being planned by the democrats could act like a cold, wet blanket on our economic future.
Thanks to Ben Cunningham who e-mailed this study to me.
