Tax and Entrepreneurship

A new report published by the TaxPayers' Alliance argues that Government tax changes will reduce the incentives to become an entrepreneur.

Introduction

There is rightly increasing political and popular concern about unemployment. In response, parties are putting in place or proposing new schemes to provide specific incentives for employers to take people off the unemployment register or take on new interns and apprentices.

These policies do little to encourage the new firms that create the vast majority of new jobs. Policy should instead be focused on encouraging entrepreneurship. Despite a notional commitment to ‘enterprise for all’ and significant public expenditure on business support services to encourage entrepreneurship, there has been little progress on that measure in recent years with just a 0.3 per cent increase in new business registrations between 1997 and 2006.

Factors Affecting The Decision to Become an Entrepreneur

Existing academic evidence suggests that a series of different pressures affect the decision to become an entrepreneur:

• People may become “necessity” entrepreneurs because of economic need or unemployment.
• They may have non-economic reasons to become, or not to become, an entrepreneur. For example, they may start a new business to be their own boss or not start one because of the social stigma attached to failing.
• Entrepreneurs are often stymied by a shortage of capital. Most small businesses are established not with bank loans but with the entrepreneur’s own money or support from their family.
• They may wish to make a lot of money. This potential reward is likely to be offset, though, by increased risk.

How Tax Policy Affects the Decision

The tax system affects the decision over whether to become an entrepreneur in two key ways:

• It may reduce the amount of capital they can access from their own wealth or their family. In particular, existing research suggests that receiving an inheritance leads to higher levels of self-employment. Inheritance Tax, in particular, may reduce the extent that entrepreneurs can obtain finance without the risks that come with a bank loan.
• The tax system undermines the large rewards that justify the risks attached to starting a new business.

When entrepreneurs earn a large amount of money they will often earn substantial amounts above the various tax thresholds, save and invest that money then eventually pass it on to their children. That money is therefore taxed repeatedly before it is spent and winds up facing a very high marginal rate:

• Under the present tax system that rate is around 90 per cent.
• With the proposed 50 per cent top tax rate, the marginal rate facing successful entrepreneurs could rise to 92 per cent. That means this measure has taken 20 per cent of the money entrepreneurs are left under the present 40 per cent top tax rate.
• Even if entrepreneurs take their initial reward as capital gains and benefit from the Entrepreneurs’ Relief, they will still face a marginal rate of 86 per cent.

The above is an extract from Tax and Entrepreneurship: How the tax system impedes the creation of new firms and decreases employment  by Dr. Jonathan M. Scott and Matthew Sinclair, which was published by the TaxPayers' Alliance (TPA), and is reproduced with their kind permission.

Article Added Sunday, 02 August 2009

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