Small Business Economics

, Volume 37, Issue 2, pp 167–185 | Cite as

Entrepreneurship and the theory of taxation



A review of the literature on firm taxation reveals that the economics of entrepreneurship has not sufficiently been taken into consideration. We discuss how this affects conclusions derived from standard models of capital taxation when applied to entrepreneurial income. Some defining features of entrepreneurship important for analyzing the effects of taxation of owner-managed firms are identified. These include the lack of a well-functioning external market for entrepreneurial effort, limited access to external capital and complementarities between entrepreneurial innovation, effort and capital. Due to these constraints, the entrepreneurial project is tied to the individual owner–manager. The entrepreneur is unable to decouple saving decisions from investment decisions, and makes joint decisions on the supply of effort and capital. The return from successful entrepreneurial ventures can therefore not be readily divided into labor and capital income, in deep contrast to what is typically assumed in taxation theory. It is argued that when distinct attributes of entrepreneurship are taken into account, certain conclusions of capital taxation models may no longer hold, including the neutrality of capital taxation in owner-managed firms. Cost of capital formulas derived from the behavior of public firms could underestimate distortions when applied to the investment behavior of entrepreneurial firms. For tax purposes and otherwise, it becomes useful to analyze return to entrepreneurial activity as income of a distinct factor of production. In this context, conceptual issues and the difficulties of measuring entrepreneurial income are discussed.


Capital income taxation Dual income taxation Entrepreneurship Innovation Institutions Labor supply New firm creation Optimal factor taxes Taxation Tax policy 

JEL Classifications

H21 H25 L5 L26 M13 O31 E25 G32 



Financial support from the Gustaf Douglas Research Program on Entrepreneurship at the Research Institute of Industrial Economics and from the Jan Wallander and Tom Hedelius Research Foundation is gratefully acknowledged. We thank Andrea Asoni, David Cesarini, Vesa Kanniainen, Linda Nyberg and Lars Persson for useful comments and suggestions.


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© Springer Science+Business Media, LLC. 2009

Authors and Affiliations

  1. 1.Research Institute of Industrial Economics (IFN)StockholmSweden
  2. 2.Harris School of Public PolicyUniversity of ChicagoChicagoUSA

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