PERSONAL INCOME TAXES AND THE GROWTH OF SMALL FIRMS

Abstract

This paper investigates the effect of entrepreneurs' personal income tax situations on the growth rates of their enterprises. We analyze the per-sonal income tax returns of a large number of sole proprietors before and after the Tax Reform Act of 1986 and determine how the substantial reductions in marginal tax rates associated with that law affected the growth of their firms as measured by gross receipts. We find that individ-ual income taxes exert a statistically and quantitatively significant influ-ence on firm growth rates. Raising the sole proprietor's tax price (one minus the marginal tax rate) by 10 percent increases receipts by about 8.4 percent. This finding is consistent with the view that raising income tax rates discourages the growth of small businesses.