Evidence Shows That High Corporate Tax Rates Lower Entrepreneurial Activity

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This article, written by economist John Phelan, was originally published on Center of the American Experiment’s website. Go to their website to read more of Phelan’s analyses.

Entrepreneurship is vital for a strong economy. Evidence shows that new firms contribute disproportionately to both gross and net job creation, play a major role in business cycles, and account for an outsized share of the innovation and aggregate productivity growth that raises living standards.

So Minnesota’s recent record is a cause for concern. As we reported last year, in 2000, new and young businesses as a share of all businesses were 41 percent in Minnesota and 43 percent nationally. By 2014, that number had fallen nationally to 34 percent but in Minnesota to 30 percent.

Figure 1: New and Young Businesses as a Share of All Businesses, 2000-2014

Source: Census Bureau

What might be causing this? New research suggests that our state’s high corporate taxes might be to blame.

In a paper titled ‘Entrepreneurship and State Taxation‘, Federal Reserve economists E. Mark Curtis and Ryan A. Decker “examine the effect of states’ corporate, personal and sales tax rates on new firm activity and test for cross-border spillovers in response to these policies”. They find that personal tax rates “have no detectable effect on startup activity” while “state sales tax rates have negative but typically statistically insignificant effects”. It is a different story, however, for corporate tax rates.

Using our border county identification strategy, we find that increases in corporate tax rates have a statistically and economically significant negative effect on employment among startup firms. Specifically, for every one percentage point increase in the corporate tax rate employment in startup firms declines 3.7 percent. In all specifications, new firm activity is shown to be considerably more responsive to corporate tax shocks than overall employment.

This might explain Minnesota’s poor recent record on entrepreneurship. As Figure 2 shows, our state has the third highest rate of corporate income tax in the country.

Figure 2: Top Rates of Corporate Income Tax, 2018

Source: The Tax Foundation

The work of Curtis and Decker shows that we can expect states with high corporate tax rates to perform poorly on entrepreneurship. Minnesota has high corporate tax rates and poor performance on entrepreneurship. Sadly, our state is just another data point in support of their findings.

John Phelan is an economist at the Center of the American Experiment. 

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