IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
WP 2011-01. Executive Summary
The paper was subsequently published in 2013 in Small Business Economics.
Numerous, and often conflicting, principles guide the design of a tax structure. One of those principles is that taxation should promote growth, or at least should hamper it as little as possible. Because innovation has been shown to be an important engine of long-term growth and development, and because innovation often takes place in settings where entrepreneurship is vibrant, a successful implementation of that principle requires that the impact of the tax structure on entrepreneurship be taken into account
The task of designing the appropriate tax structure is nowadays quite difficult, and the fact that economies are more globalized makes it even more complex. Because economic and financial crises can cause significant increases in unemployment, governments may be tempted to alter the tax structure by introducing new taxes or increasing marginal tax rates, instead of cutting government spending. But this new or higher tax burden could in turn constitute an impediment to entrepreneurship, growth, employment and tax revenues. To progress in that discussion on the appropriate tax structure, more empirical work on the impact of higher taxes on entrepreneurial activity is warranted. Such work may provide useful insight that could help explain why this type of fiscal policy (increasing taxes as opposed to cutting government spending) may have a negative impact on growth.
In this paper, the authors we examine how the tax structure affects entrepreneurship in a large group of European countries. To do this, we use country data on nascent entrepreneurship from the Global Entrepreneurship Monitor (GEM) and relevant tax rates from the Organization for Economic Co-operation and Development (OECD) Tax Database. More specifically, using panel data for 2000-2008, the paper addresses two main objectives.
> First, controlling for other relevant variables, they try to explore whether tax increases discourage entrepreneurial activity, focusing on the effects on new self-employment (nascent entrepreneurship).
> Second, they investigate the impact of tax progressivity on new self-employment.
The authors find that tax progressivity at higher-than-average incomes has a robust negative effect on nascent entrepreneurship. They discuss the policy implications of our results.
This study differs from existing empirical work using European data because it uses macro-level panel data (the literature contains mostly studies using micro-level data due mainly to the difficulty to incorporate the concept of tax progressivity at the macro-level) and makes the distinction between the effect of taxes and tax progressivity on new entrepreneurial activity (nascent entrepreneurship) using several measures of taxation.
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