The effects of income taxation on entrepreneurial investment: A puzzle?
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The effects of income taxation on entrepreneurial investment: A puzzle? Frank M. Fossen1,2 · Ray Rees3 · Davud Rostam‑Afschar4,5 · Viktor Steiner6
© Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract We investigate how personal income taxes affect the portfolio share of personal wealth that entrepreneurs invest in their own business. In a portfolio choice model that allows for tax sheltering, we show that lower tax rates may increase investment in entrepreneurial equity at the intensive margin, but decrease it at the extensive margin. Using German panel data, we identify tax effects on the portfolio shares of six asset classes by exploiting tax and entry regulation reforms. Our results indicate that lower taxes drive out businesses that are viable only due to tax sheltering, but increase investment in productive entrepreneurial businesses. Keywords Taxation · Entrepreneurship · Portfolio choice · Tax sheltering · Investment JEL Classification H24 · H25 · H26 · L26 · G11
* Frank M. Fossen [email protected] Ray Rees [email protected]‑muenchen.de Davud Rostam‑Afschar rostam‑afschar@uni‑mannheim.de Viktor Steiner viktor.steiner@fu‑berlin.de 1
Department of Economics, University of Nevada, Reno, NV 89557‑0030, USA
2
IZA, Bonn, Germany
3
CES, Faculty of Economics, Ludwig-Maximilians-Universität München, Schackstr. 4, 80539 Munich, Germany
4
Universität Mannheim, 68131 Mannheim, Germany
5
Universität Hohenheim, 70593 Stuttgart, Germany
6
Department of Economics, Freie Universität Berlin, Boltzmannstr. 20, 14195 Berlin, Germany
13
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F. M. Fossen et al.
1 Introduction Taxes influence the decisions of households on which assets to hold and how much to invest in each asset type. A growing empirical literature has analyzed the effects of personal income taxes on household portfolio allocation (Feldstein 1976; Hub‑ bard 1985; King and Leape 1998; Poterba 2002a, b; Poterba and Samwick 2002; Alan et al. 2010; Ochmann 2014). The literature considers tax effects on investment in assets such as owner-occupied housing and various forms of financial assets. However, the literature is mostly silent about the impact of taxes on private business equity, i.e., the share of wealth that entrepreneurial households invest in their own businesses. Closing this knowledge gap is an important task from the perspectives of academics and policymakers. In Germany (the USA), 8% (9%) of the population own private business equity, and these entrepreneurs on average allocate as much as 40% (42%) of their wealth to their own businesses. Although entrepreneurial households form a minority among households, they hold a large share of aggregate wealth because they are much wealthier on average than other households: The aver‑ age net worth of entrepreneurs is more than five times as much as that of non-entre‑ preneurs in Germany and even seven times as much in the USA.1 Thus, tax effects on entrepreneurial portfolio allocation may dominate tax effects on aggregate capital allocation in the econ
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