Income taxes and entrepreneurial choice: empirical evidence from two German natural experiments

Abstract

Does tax policy affect entrepreneurial choice? We use two tax reforms in Germany as “natural experiments”. These reforms reduced the marginal income tax rate for entrepreneurs with income above a certain threshold, with the exception of freelance professionals. The two conditions for belonging to the treatment group allow us to apply a “difference-in-difference-in-difference” identification strategy to estimate the effects of the tax rate reductions. We base our analysis on the microcensus, the official representative continuous household survey in Germany. The results indicate that the tax rate reductions increased the probability of choosing self-employment.

This is a preview of subscription content, log in to check access.

References

  1. Ai C, Norton EC (2003) Interaction terms in logit and probit models. Econ Lett 80(1): 123–129

    Article  Google Scholar 

  2. Bach S, Corneo G, Steiner V (2005) Top incomes and top taxes in Germany. German Institute for Economic Research, DIW Discussion Paper 532

  3. Bach S, Broer M, Fossen FM (2008) Sollen Freiberufler und Landwirte Gewerbesteuer zahlen? Steuersystematische Überlegungen und empirische Wirkungsanalysen. German Institute for Economic Research, DIW Discussion Paper 761

  4. Blundell R, Costa Dias M (2002) Alternative approaches to evaluation in empirical microeconomics. The Institute for Fiscal Studies, cemmap working paper 10/02

  5. Brown S, Farrel L, Sessions JG (2006) Self-employment matching—an analysis of dual earner couples and working households. Small Bus Econ 26(2): 155–172

    Article  Google Scholar 

  6. Bruce D (1999) Do husbands matter? married women entering self-employment. Small Bus Econ 13(4): 317–329

    Article  Google Scholar 

  7. Bruce D (2000) Effects of the United States tax system on transitions into self-employment. Labour Econ 7(5): 545–574

    Article  Google Scholar 

  8. Bruce D (2002) Taxes and entrepreneurial endurance: evidence from the self-employed. Natl Tax J 55(1): 5–24

    Google Scholar 

  9. Cullen JB, Gordon RH (2002) Taxes and entrepreneurial activity: theory and evidence for the US. National Bureau of Economic Research, NBER Working Paper W9015

  10. Domar ED, Musgrave RA (1944) Proportional income taxation and risk-taking. Q J Econ 58(3): 388–422

    Article  Google Scholar 

  11. Evans DS, Leighton LS (1989) Some empirical aspects of entrepreneurship. Am Econ Rev 79(3): 519–535

    Google Scholar 

  12. Federal Constitutional Court (1977) Entscheidungen des Bundesverfassungsgerichts. Amtliche Sammlung 46:224–241

  13. Federal Ministry of Finance (1994) Stand und voraussichtliche Entwicklung der Finanzwirtschaft im gesamtwirtschaftlichen Zusammenhang. Finanzbericht

  14. Federal Ministry of Finance (1999) Stand und voraussichtliche Entwicklung der Finanzwirtschaft im gesamtwirtschaftlichen Zusammenhang. Finanzbericht

  15. Feldstein M (1995) The effect of marginal tax rates on taxable income: a panel study of the 1986 tax reform act. J Polit Econ 103(3): 551–572

    Article  Google Scholar 

  16. Gentry WM, Hubbard RG (2000) Tax policy and entrepreneurial entry. Am Econ Rev 90(2): 283–287

    Google Scholar 

  17. Georgellis Y, Wall HJ (2002) Entrepreneurship and the policy environment. The Federal Reserve Bank of St. Louis, Working Paper 2002–019B

  18. German Bundestag (2003) Entwurf eines Gesetzes zur Reform der Gewerbesteuer. Drucksache 15/1517

  19. Gruber J (1994) The incidence of mandated maternity benefits. Am Econ Rev 84(3): 622–641

    Google Scholar 

  20. Haan P, Steiner V (2005) Distributional effects of the German tax reform 2000—a behavioral microsimulation analysis. J Appl Soc Sci Stud 125(1): 39–49

    Google Scholar 

  21. Long JE (1982a) Income taxation and the allocation of market labor. J Labor Res 3(3): 259–276

    Article  Google Scholar 

  22. Long JE (1982b) The income tax and self-employment. Natl Tax J 35(1): 31–42

    Google Scholar 

  23. Moore K (2004) The effects of the 1986 and 1993 tax reforms on self-employment. Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series Working Paper 2004–05

  24. Parker SC (1996) A time series model of self-employment under uncertainty. Economica 63(241): 459–475

    Article  Google Scholar 

  25. Parker SC (2003) Does tax evasion affect occupational choice. Oxf Bull Econ Stat 63: 379–394

    Article  Google Scholar 

  26. Parker SC (2005) Entrepreneurship among married couples in the United States–a simultaneous probit approach. Institute for the Study of Labor (IZA), IZA Discussion Paper 1712

  27. Schuetze HJ (2000) Taxes, economic conditions and recent trends in male self-employment: a Canada-US comparison. Labour Econ 7(5): 507–544

    Article  Google Scholar 

  28. Schuetze HJ, Bruce D (2004) Tax policy and entrepreneurship. Swed Econ Policy Rev 11(2): 223–265

    Google Scholar 

  29. Taylor MP (1996) Earnings, independence or unemployment: why become self-employed. Oxf Bull Econ Stat 52(2): 253–265

    Google Scholar 

Download references

Author information

Affiliations

Authors

Corresponding author

Correspondence to Frank M. Fossen.

Rights and permissions

Reprints and Permissions

About this article

Cite this article

Fossen, F.M., Steiner, V. Income taxes and entrepreneurial choice: empirical evidence from two German natural experiments. Empir Econ 36, 487–513 (2009). https://doi.org/10.1007/s00181-008-0208-z

Download citation

Keywords

  • Taxation
  • Entrepreneurship
  • Natural experiment
  • Difference-in-difference-in-difference

JEL Classification

  • H24
  • H25
  • J23