Abstract:

We examine the effects of personal income tax progressivity ⎯ in the sense of rising marginal income tax rate ⎯ on self-employment. Our simple analytical framework shows that the impacts of income tax progressivity on self-employment depend on the relative effects of taxing success and the presence of tax evasion opportunities. Empirical estimates using Canadian provincial data for the period 1979-2006 indicate that there is a negative association between income tax progressivity and self-employment. This suggests that the adverse impact of income tax on entrepreneurial risk-taking outweighs the tax evasion opportunities for the self-employed. An important implication of our results is that a reduction in income tax progressivity encourages self-employment. The empirical estimates are robust to the various sensitivity checks