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Part 3 in a Series on the Minnesota Corporate Income Tax Debate: Higher Rates Mean Fewer Jobs

In our last two posts in this series, we looked at the effects of marginal corporate income tax rates on investment and Foreign Direct Investment (FDI), as reported in peer-reviewed economic journal articles. Today, we look at the effects of marginal corporate income tax rates on the number of businesses and the creation of new businesses.

Entrepreneurs are the people who take an idea and transform it into a business. In doing so, they provide valuable goods or services to their customers, and new employment opportunities for others. Entrepreneurial startup companies also are important players in introducing new ideas and business methods into the economy, ushering in innovations that improve the lives of consumers. Finally, startup companies create a disproportionate number of new jobs. According to economists John C. Haltiwanger, Ron S. Jarmin, and Javier Miranda, “firm startups account for only 3 percent of employment but almost 20 percent of gross job creation.” (p.31)

One way to measure a nation’s success in creating businesses is to look at the number of formally organized and registered businesses. Naturally, you’d want to adjust for population, as a big country ought to have more businesses than a small one. Djankov, et. al. (2010) used a ratio, looking at the number of companies per 100 people of working age.

(To be precise, they looked at “the number of registered limited liability corporations per 100 members of the working-age population as of 2004,” and called this the “business density” variable.)

What did Djankov and his co-authors find when they ran the numbers? They concluded, “The effects of taxes on our measures of entrepreneurship are large and statistically significant, and show up with both the statutory and the effective tax rates.” In other words, tax rates matter. They continue, “A 10 percentage point increase in the first-year effective corporate tax rate reduces business density by 1.9 firms per 100 people.”

In addition to looking at the number of businesses, period, we might want to look at the number of new businesses, which represent new opportunities, new ideas, and new blood. Djankov and his co-authors looked for the ratio of new businesses to working-age adults, each year for five years.

(To be precise, they examined “the average number of limited liability corporations (or their country-specific equivalent) that were registered per year between 2000 and 2004. Only businesses with more than one employee that are not sole proprietorships are included. The variable is measured as a percentage of the stock of such firms.” They label this the entry rate variable.)

They concluded, “a 10 percentage point increase in the first-year effective corporate tax rate reduces the average entry rate by 1.4 percentage points.” In other words, higher tax rates mean fewer new businesses offering goods and services, and employment.

The results are clear: higher marginal corporate income tax rates reduce entrepreneurship. Fewer start-up companies mean fewer jobs created.

For earlier posts in this series, see part 1 and part 2.