Tax policy and entrepreneurship: empirical evidence from Sweden

For an overview of earlier studies, see e.g., Schuetze and Bruce (2004).

One of the studies (Parker 1996) is based on data from the U.K., while another (Parker and Robson 2003) is based on Organisation for Economic Co-operation and Development (OECD) data.

To my knowledge there are no estimates on how taxes affect self-employment based on Swedish longitudinal individual-based data. A study by Fölster (2002) using aggregate data from Swedish counties found that the average top-income tax rate in the county is negatively correlated with self-employment. Similarly, Backman (2007) found municipal income taxes to negatively influence start-ups in Sweden. Nyström (2007), however, failed to find a significant relationship between municipal taxes and start-ups.

If individuals reporting any income from the above-mentioned business ventures are counted as self-employed, the percentage of self-employed increases to 6.9%.

One can speculate whether the substantially higher taxable wealth for the self-employed is a consequence of higher returns to self-employment or whether the wealth was initially higher, and maybe even a requirement for becoming self-employed. The fact that reported taxable income is lower for self-employed than employees could imply that wealth was not built up from the business venture. There can, however, be a large discrepancy between real income and reported taxable income, especially for self-employed who have greater ability to affect their taxable income (Persson 2005; Engström and Holmlund 2009). Engström and Holmlund, for instance, estimated that self-employed underestimate their business income by as much as 35%. If that is the case, the average real income for self-employed is larger than the average real income for employees (given that they have little or no ability to affect their taxable income). However, the average yearly growth rate in taxable wealth among self-employed was lower than among employees, suggesting that the self-employed initially possessed their wealth.

Prior to the 1990/1991 tax reform, self-employed had greater ability to avoid taxes than self-employed, as self-employed had extensive deduction possibilities. Years prior to the 1990/1991 tax reform were chosen, as many tax rate changes would be lost if years prior to this reform were excluded. Excluding years before the reform does not change the results, however (as shown in sensitivity analysis in Section 6).

The average and marginal tax rates are not reported in LINDA but can easily be calculated for each individual by using the information provided in LINDA.

The definition of taxable wealth has changed slightly over the years but includes own homes at their assessment value (75% of the market value). Stocks and interest-bearing assets are also included, with the former generally counted at 75–80% of their market value (some stocks are excluded, and owners that possess more than 25% of the total stocks in a firm are exempt on this possession), and the latter at 100% of their market value. In 2000, taxable wealth above SEK 900,000 was taxed at 1.5%. In 2007, the wealth tax was abolished.

The final results are not sensitive to variables included in this probit regression.

This is in line with results from Bruce (2000), as he found the inverse Mills ratio to be statistically significant while not showing any noticeable effect on the results.

Taxable wealth is not an ideal proxy for access to private capital as only wealth that is taxable is included and only above a threshold. Individuals’ capital income is alternatively used as a proxy for access to private capital. Capital income has a positive and highly statistically significant impact on the decision to become self-employed. Using capital income instead of taxable wealth, however, does not alter the impact of the tax rates on the occupational choice.

The negative correlation between tax rates and the probability of becoming self-employed is found in linear estimation models employing both fixed and random effects, and with and without individual-specific effects. The negative correlation is also present in logit estimation models. The results are not sensitive to the inclusion of alternative explanatory variables.

Part of the tax reform entailed a switch to a dual income tax system, taxing labor income at a higher rate and capital income at a lower tax rate. In order not to create incentives for self-employed to shift labor income to lower-taxed capital income, special rules (the so called 3:12 rules) were created to minimize this problem.

Specifically the logarithmic difference in taxable wealth between 2 years is regressed on the logarithmic difference in average and marginal tax rates, respectively, in addition to a number of control variables (age, marriage, labor and capital income, and education).