Taxes and Business Creation

by cactus

Taxes and Business Creation

When you cut taxes, it leads to the creation of new businesses. By cutting taxes, people keep more of their hard earned money which gives them the resources to start new businesses. The cut in taxes also encourages people to take more risk knowing the fruit of their efforts is not going to be seized by the government and used on homeless orphans or other loafers. And its not all about folks getting off the couch and entering the business world – a low tax regime encourages those who are already in business to expand. Conversely, as we have been reminded ad nauseum as of late, rising taxes provide a disincentive to the producing class, whereupon their full-time occupation becomes going Galt (with occasional breaks to join together in large groups for some good old-fashioned collective Tea Bagging).

Of particular importance are cuts in marginal tax rates; potential entrepreneurs make their decisions at the margin.

This is all pretty basic stuff – you’ll find it in textbooks. But does the real world match up with the pretty theory? We’ll never know unless we find some data. So I got me some primo data. And as they say about data, flaunt it if you got it.

Up first is this cute sample from the IRS, which gives us the number of corporations, partnerships, and non-farm proprietorships filing taxes from 1990 to 2006. We can augment that by summing all those figures to get a “total business filings” figure. I figure the lower-taxes-leads-to-company-formation story allows us to break the 1990 to 2006 period into the following groupings:

1. Bush Sr. era (through 92)
2. Clinton era of tax hikes (through 96)
3. Clinton period including and following the cut in capital gains taxes (through 00)
4. Bush era or tax cuts (through 03)
5. Bush era once all the tax cuts have kicked in. (through 06)

Presumably, when it comes to the number of businesses, growth should be slower in Clinton’s tax hike era than in the Bush Sr. era before it – after all, taxes were higher. There should be much faster increases once the capital gains tax cut kicked in – it had both lower taxes plus faster economic growth, after all. 01 to 03 should see faster increases still as taxes came down further, but only slightly faster since the economy sucked at the time. However, from 03 to 06 we should see monster growth in business formation; taxes were lowest of all (following the cap gains tax cuts in 07 and the 01 to 03 cuts in marginal personal income taxes), plus those were the best years of the Bush Jr. era.

So here’s what it all looks like:

Well, this is disappointing. This graph really does not seem to conform to verses three through seventeen of Chapter One of the Gospel of St. Ronnie. The closest we get (and frankly, its not very close) to a pattern compatible with Revealed Truth is with partnerships, but there are a lot fewer partnerships than corporations or sole proprietorships. (e.g., in 06 there were 5.8 million corporations, 2.9 million partnerships, and 22 million sole proprieterships).

OK. So maybe this data sucks. The number of companies may not mean anything – many of these may simply be, er, vehicles for reducing one’s tax burden. So maybe we have to go elsewhere to get the kind of results that all the good people in the Robert-Mundell-to-Glenn-Beck spectrum would recognize.

And maybe we have to look at other things, like job creation, or the size of payrolls.

I pulled stuff like that from this SBA doc which in turn gets its data from the Census. The data goes back to 1988, but the breakdown of periods is essentially the same, except that now we can look a the change over the entire Bush Sr. era.

This time we can look at the change in the number of firms, the number of establishments (a company can set up multiple establishments – think of a restaurant chain opening up another location), number of employees a these firms, and payroll. (I adjusted the payroll figures for inflation using the CPI.

So here’s what that looks like:

Well, this isn’t cutting it either. The best period for firm formation is following Clinton’s tax hikes. The period with the fastest increases in employment and firm payrolls come after the cap gains tax cuts, but before the Bush tax cuts… and the second best period employment and payroll-wise comes after Clinton’s tax hikes. Clearly the data has to get with the program if its going to pass theoretical muster with the Chicago school or at the U of Minnesota, much less at Cato or with Sarah Palin. And let’s not even get started with the Austrians…

But the results might go a long way toward explaining this.

Smoke ’em if you got ’em.
by cactus