Tax policies and corruption are important institutional considerations which can shape entrepreneurship. We investigate how tax rates, and the interaction between corruption and tax rates, influence variations in entry across a panel of 72 countries in the period 2005–2011. We use a series of panel estimations as well as several robustness checks to test these effects, using relevant controls for economic development, the size of the state, and other regulatory and tax policy measures. We find that higher tax rates consistently discourage entry. Further, we find that although the direct influence of corruption on entry is also consistently negative, the interaction influence of corruption and tax rate is positive. This indicates that corruption can offset the negative influence of high taxes on entry. We discuss the implications of our findings for policymakers and future research.
This is a preview of subscription content,to check access.
Access this article
Many studies, mostly pre-mid-2000s, proxied entrepreneurship as self-employment (see Ács et al. 2014; Bruce 2000, 2002; Gentry and Hubbard 2000; Parker 1996). Some found a positive relationship between tax rate and self-employment in developed countries. Evans and Leighton (1989a, b) and Blau (1987) studied the US context, and Bacher and Brülhart (2010) studied the Swiss context, both finding a positive relationship of tax progressivity and self-employment. However, some found negative, mixed, or insignificant effects. A negative influence of marginal tax rate on self-employment was found for Canadian microdata (Stabile 2004); similar findings emerged for the US and Canada (Schuetze 2000) and the UK (Parker 1996; Blanchflower and Oswald 1990). For Sweden, Fölster (2002) and Davis and Henrekson (1999) found a negative relationship between tax rates and self-employment, and Hansson (2012) found a negative relationship for both marginal and average tax rates. Another set of studies found no significance for tax rate and self-employment (Baliamoune-Lutz and Garello 2014; Bruce and Mohsin 2006; Parker 2003; OECD 2000). Mixed findings of different measures are not unusual: Robson and Wren (1999) studied OECD countries and found a positive relationship of self-employment with average tax rate, but a negative relationship with marginal tax rate. The distinction between self-employment (labor market trend) versus entry (new firm formation) has emerged, e.g related to educational level (Blanchflower 2004; Parker 2009) or conditions of unemployment and necessity (Arum and Müller 2004a, b). We do not examine self-employment in this study as we concerned with businesses most likely influenced by tax rates: new formal firms. For more on self-employment versus entrepreneurship, see Blanchflower (2004), Parker (2009) and Arum and Müller (2004a, b).
Value-added tax (VAT) is another tax policy tool which could enhance the desirability of corruption. Although many countries have adopted VAT, individuals might not register their business to lower tax liability, or register but submit personal expense invoices as business expense (Alm 2012; Gordon and Li 2009). Another strategy could be to buy or sell from firms owned by the same individual, within a country or overseas.
Two things are noteworthy about our time period, 2005–2011, which was restricted by data availability. First, results could be affected by the global recession, which occurred during this period. We accept this as a limitation which can be illuminated in future research as data availability improves. Second, as we detail in our discussion of the dependent variable, we use formal entry density to measure entrepreneurship. This standardized measure counts limited liability companies in a country using a well-defined process, so our measure captures registered firms which we infer to have been able to pay registration costs (and therefore would comply with tax and other regulations in the future), and are likely to have more financial resources than the self-employed or other entrepreneurs who act because they lack other opportunities (necessity entrepreneurship). The use of this specific measure for entrepreneurship, to some degree, protects our results from being affected drastically by the recession.
We are grateful to one of the reviewers of this paper for this suggestion.
We also conducted a set of checks using a third measure of corruption from the Heritage Foundation’s Index of Economic Freedom. This measure is derived in part with Transparency International (TI) and is correlated with the CPI measure (+92), so we do not report it here and consider the use of CPI adequate for our purposes.
Ács, Z. J., Autio, E., & Szerb, L. (2014). National systems of entrepreneurship: Measurement issues and policy implications. Research Policy, 43(3), 476–494.
Acs, Z. J., Braunerhjelm, P., Audretsch, D. B., & Carlsson, B. (2009). The knowledge spillover theory of entrepreneurship. Small Business Economics, 32(1), 15–30.
Acs, Z. J., Desai, S., & Klapper, L. F. (2008). What does “entrepreneurship” data really show? Small Business Economics, 31(3), 265–281.
Aidis, R., Estrin, S., & Mickiewicz, T. (2012). Size matters: Entrepreneurial entry and government. Small Business Economics, 39, 119–139.
Alm, J. (2012). Measuring, explaining, and controlling tax evasion: Lessons from theory, experiments, and field studies. International Tax and Public Finance, 19(1), 54–77.
Anokhin, S., & Schulze, W. S. (2009). Entrepreneurship, innovation, and corruption. Journal of Business Venturing, 24(5), 465–476.
Appelbaum, E., & Katz, E. (1996). Corporate taxation, incumbency advantage and entry. European Economic Review, 40, 1817–1828.
Arum, R., & Müller, W. (2004a). The return of self-employment: A cross-national study of self-employment and social inequality. Princeton: Princeton University Press.
Arum, R., & Müller, W. (2004b). The reemergence of self-employment: Comparative findings and empirical propositions. In R. Arum & W. Müller (Eds.), The reemergence of self-employment. A comparative study of self-employment dynamics and social inequality (pp. 426–454). Princeton, Oxford: Princeton University Press.
Audretsch, D. B., & Belitski, M. (2013). The missing pillar: The creativity theory of knowledge spillover entrepreneurship. Small Business Economics, 41(4), 819–836.
Audretsch, D., Belitski, M., & Desai, S. (2015). Entrepreneurship and economic development in cities. Annals of Regional Sciences, 55(1), 33–60.
Audretsch, D. B., & Feldman, M. P. (1996). R&D spillovers and the geography of innovation and production. The American Economic Review, 86, 630–640.
Audretsch, D. B., & Lehmann, E. E. (2005). Does the knowledge spillover theory of entrepreneurship hold for regions? Research Policy, 34(8), 1191–1202.
Bacher, H. U., & Brülhart, M. (2010). Progressive taxes and firm births. Working paper, CEPR DP7830. www.cepr.org/pubs/dps/DP7830.asp.
Baker, T., Gedajlovic, E., & Lubatkin, M. (2005). A framework for comparing entrepreneurship processes across nations. Journal of International Business Studies, 36(5), 492–504.
Baliamoune-Lutz, M. (2015). Taxes and entrepreneurship in OECD countries. Contemporary Economic Policy, 33(2), 369–380.
Baliamoune-Lutz, M., & Garello, P. (2014). Tax structure and entrepreneurship. Small Business Economics, 42, 165–190.
Baumol, W. J. (1990). Entrepreneurship, productive, unproductive, and destructive. Journal of Political Economy, 98(5), 893–921.
Belitski, M., & Desai, S. (2015). What drives ICT clustering in European cities? The Journal of Technology Transfer. doi:10.1007/s10961-015-9422-y
Blanchflower, D. G. (2004). Self-employment: More may not be better. No. w10286. National Bureau of Economic Research.
Blanchflower, D., & Oswald, A. (1990). What makes a young entrepreneur? No. 373.
Blau, D. (1987). A time series analysis of self-employment in the United States. Journal of Political Economy, 95, 223–239.
Bologna, J., & Ross, A. (2015). Corruption and entrepreneurship: Evidence from a random audit program. No. 15-05.
Braithwaite, J. (2006). Responsive regulation and developing economies. World Development, 34(5), 884–898.
Bruce, D. (2000). Effects of the United States tax system on transitions into self-employment. Labour Economics, 7(5), 545–574.
Bruce, D. (2002). Taxes and entrepreneurial endurance, evidence from the self-employed. National Tax Journal, 54(1), 5–24.
Bruce, D., & Mohsin, M. (2006). Tax policy and entrepreneurship: New time series evidence. Small Business Economics, 26(5), 409–425.
Campos, N., Dimova, R., & Saleh, A. (2010). Whither corruption? A quantitative survey of the literature on corruption and growth. CEPR discussion paper no. 8140.
Carree, M., van Stel, A., Thurik, R., & Wennekers, S. (2002). Economic development and business ownership: An analysis using data of 23 OECD countries in the period 1976–1996. Small Business Economics, 19, 271–290.
Carroll, R., Holtz-Eakin, D., Rider, M., & Rosen, H. S. (2001). Personal income taxes and the growth of small firms. In J. Poterba (Ed.), Tax policy and the economy (Vol. 15, pp. 121–147). Cambridge, MA: MIT Press.
Chowdhury, F., Desai, S., Audretsch, D. B., & Belitski, M. (2015). Does corruption matter for international entrepreneurship? International Entrepreneurship and Management Journal, 11(4), 959–980.
Coase, R. H. (1960). The problem of social cost (pp. 87–137). London: Palgrave Macmillan.
Cuervo-Cazurra, A. (2006). Who cares about corruption? Journal of International Business Studies, 37(6), 807–822.
Cullen, J. B., & Gordon, R. H. (2007). Taxes and entrepreneurial risk-taking: Theory and evidence for the US. Journal of Public Economics, 91(7), 1479–1505.
Da Rin, M., Di Giacomo, M., & Sembenelli, A. (2011). Entrepreneurship, firm entry, and the taxation of corporate income: Evidence from Europe. Journal of Public Economics, 95(9), 1048–1066.
Davis, S. J., & Henrekson, M. (1999). Explaining national differences in the size and industry distribution employment. Small Business Economics, 12(1), 59–83.
Desai, S., Acs, Z., & Weitzel, U. (2013). A model of destructive entrepreneurship insight for conflict and postconflict recovery. Journal of Conflict Resolution, 57(1), 20–40.
Djankov, S., Ganser, T., McLiesh, C., Ramalho, R., & Shleifer, A. (2010). The effect of corporate taxes on investment and entrepreneurship. American Economic Journal: Macroeconomics, 2, 31–64.
Djankov, S., LaPorta, R., Lopez-De-Silanes, F., & Shleifer, A. (2002). The regulation of entry. Quarterly Journal of Economics CXVII, 1, 1–36.
Doerrenberg, P., & Peichl, A. (2013). Progressive taxation and tax morale. Public Choice, 155(3–4), 293–316.
Domar, E. D., & Musgrave, R. A. (1944). Proportional income taxation and risk-taking. Quarterly Journal of Economics, 58(3), 388–422.
Dreher, A., & Gassebner, M. (2013). Greasing the wheels? The impact of regulations and corruption on new firm entry. Public Choice, 155(3–4), 1–20.
Estrin, S., Korosteleva, J., & Mickiewicz, T. (2013). Which institutions encourage entrepreneurial growth aspirations? Journal of Business Venturing, 28, 564–580.
Estrin, S., Meyer, K. E., & Bytchkova, M. (2006). Entrepreneurship in transition economies. In M. C. Casson, et al. (Eds.), The Oxford Handbook of Entrepreneurship. Oxford: Oxford University Press.
Evans, D. S., & Leighton, L. S. (1989a). Some empirical aspects of entrepreneurship. The American Economic Review, 79(3), 519–535.
Evans, D. S., & Leighton, L. S. (1989b). The determinants of changes in US self-employment, 1968–1987. Small Business Economics, 1(2), 111–119.
Fölster, S. (2002). Do lower taxes stimulate self-employment? Small Business Economics, 19, 135–145.
Fossen, F., & Steiner, V. (2009). Income taxes and entrepreneurial choice: Empirical evidence from two German natural experiments. Empirical Economics, 36, 487–513.
Fritsch, M., & Schroeter, A. (2011). Why does the effect of new business formation differ across regions? Small Business Economics, 36, 383–400.
Gentry, W. M., & Hubbard, R. G. (2000). Tax policy and entrepreneurial entry. The American Economic Review, 90(2), 283–287.
Gentry, W. M., & Hubbard, R. G. (2004). Success taxes, entrepreneurial entry, and innovation (Vol. 10551). NBER working paper.
Gordon, R., & Li, W. (2009). Tax structures in developing countries: Many puzzles and a possible explanation. Journal of Public Economics, 93(7), 855–866.
Gurley-Calvez, T., & Bruce, D. (2013). Do tax rate cuts encourage entrepreneurial entry? Journal of Entrepreneurship and Public Policy, 2(2), 178–202.
Hansson, Å. (2012). Tax policy and entrepreneurship: Empirical evidence from Sweden. Small Business Economics, 38, 495–513.
Henrekson, M., Johansson, D., & Stenkula, M. (2010). Taxation, labor market policy and high-impact entrepreneurship. Journal of Industry, Competition and Trade, 10(3–4), 275–296.
Kaufmann, D., Kraay, A., & Mastruzzi, M. (2006). Governance matters V: Governance indicators for 1996–2005. World Bank policy research working paper.
Keuschnigg, C., & Nielsen, S. B. (2002). Tax policy, venture capital, and entrepreneurship. Journal of Public Economics, 87(1), 175–203.
Klapper, L., Laeven, L., & Rajan, R. (2006). Entry regulation as a barrier to entrepreneurship. Journal of Financial Economics, 82(3), 591–629.
Klapper, L., & Love, I. (2010). The impact of business environment reforms on new firm registration. World Bank policy research working paper 5493.
Kobrin, S. J. (1978). When does political instability result in increased investment risk. Columbia Journal of World Business, 13(3), 113–122.
Korosteleva, J., & Mickiewicz, T. (2011). Startup finance in the age of globalisation. Emerging Markets Finance and Trade, 47(3), 23–49.
Mahagaonkar, P. (2008). Corruption and innovation: A grease or sand relationship? No. 017. Jena economic research papers.
McMullen, J. S., Bagby, D., & Palich, L. E. (2008). Economic freedom and the motivation to engage in entrepreneurial action. Entrepreneurship Theory and Practice, 32(5), 875–895.
Méon, P.-G., & Sekkat, K. (2005). Does corruption grease or sand the wheels of growth? Public Choice, 122(1), 69–97.
OECD. (2000). The employment outlook. Paris: OECD.
Parker, S. (1996). A time series model of self-employment under uncertainty. Economica, 63(251), 459–475.
Parker, S. C. (2003). Does tax evasion affect occupational choice? Oxford Bulletin of Economics and Statistics, 65, 379–394.
Parker, S. C. (2009). The economics of entrepreneurship. Cambridge: Cambridge University Press.
Pathak, S., Xavier-Oliveira, E., & Laplume, A. O. (2015). Entrepreneurship in transition economies: The role of corruption and individual attributes. Journal of Balkan and Near Eastern Studies, 17(4), 427–446.
Robson, M. T., & Wren, C. (1999). Marginal and average tax rates and the incentives for selfemployment. Southern Economic Journal, 65(4), 757–773.
Rodríguez-Pose, A., & Storper, M. (2006). Better rules or stronger communities? On the social foundations of institutional change and economic effects. Economic Geography, 82(1), 1–25.
Romer, P. (1994). New goods, old theory, and the welfare cost of trade restrictions. Journal of Development Economics, 43(1), 5–38.
Schuetze, H. J. (2000). Taxes, economic conditions and recent trends in male self-employment: A Canada–US comparison. Labour Economics, 7(5), 507–544.
Shleifer, A., & Vishny, R. W. (1993). Corruption. Quarterly Journal of Economics, 108(3), 599–617.
Shleifer, A., & Vishny, R. W. (1994). Politicians and firms. Quarterly Journal of Economics, 109, 995–1026.
Shleifer, A., & Vishny, R. W. (2002). The grabbing hand: Government pathologies and their cures. Cambridge: Harvard University Press.
Sobel, R. S. (2008). Testing Baumol: Institutional quality and the productivity of entrepreneurship. Journal of Business Venturing, 23(6), 641–655.
Stabile, M. (2004). Payroll taxes and the decision to be selfemployed. International Tax and Public Finance, 11, 31–53.
Stenholm, P., Acs, Z. J., & Wuebker, R. (2013). Exploring country-level institutional arrangements on the rate and type of entrepreneurial activity. Journal of Business Venturing, 28(1), 176–193.
Tanzi, V., & Davoodi, H. R. (2000). Corruption, growth, and public finances, IMF Working Paper No. 00/182.
Thai, M. T. T., & Turkina, E. (2014). Macro-level determinants of formal entrepreneurship versus informal entrepreneurship. Journal of Business Venturing, 29(4), 490–510.
Tonoyan, V., Strohmeyer, R., Habib, M., & Perlitz, M. (2010). Corruption and entrepreneurship: How formal and informal institutions shape small firm behavior in transition and mature market economies. Entrepreneurship Theory and Practice, 34(5), 803–831.
Torrini, R. (2005). Cross-country differences in self-employment rates: The role of institutions. Labour Economics, 12(5), 661–683.
van Stel, A., Storey, D., & Thurik, A. (2007). The effect of business regulations of nascent and young business entrepreneurship. Small Business Economics, 28(2–3), 171–186.
Webb, J. W., Tihanyi, L., Ireland, R. D., & Sirmon, D. G. (2009). You say illegal, I say legitimate: Entrepreneurship in the informal economy. Academy of Management Review, 34(3), 492–510.
Weston, V. F., & Sorge, B. W. (1972). International Managerial Finance. Homewood, IL: Richard D. Irwin Inc.
We thank David Audretsch, Johan Eklund, Magnus Henrekson, and participants at Academy of International Business for comments. Farzana Chowdhury thanks Erik Stam and Siri Terjesen.
About this article
Cite this article
Belitski, M., Chowdhury, F. & Desai, S. Taxes, corruption, and entry. Small Bus Econ 47, 201–216 (2016). https://doi.org/10.1007/s11187-016-9724-y