22 March, 2023
HFI notes no. 3: The Taxation of entrepreneurs differs considerably over time
The institutional literature suggests that long-term tax incentives are crucial for entrepreneurs. Still, theoretical and empirical problems related to how to define and measure entrepreneurial income hamper studies on this topic suffer. In a recently published article, we resolve these problems by drawing on a theoretical definition of the entrepreneur as an owner. The owner-entrepreneur definition enables us to empirically identify entrepreneurship through investments made by active owners of closely held firms.
We use detailed Swedish tax data to analyze the tax incentives for owner-entrepreneurs’ investments from 1862 to 2018. We calculate the annual marginal effective tax rate (METR) on capital income for investments, distinguishing between average- and top-income entrepreneurs and between three sources of finance. We identify five tax regimes that indicate substantial differences in taxation over time. The analysis sheds new light on the development of the Swedish economy across 160 years.
Taxes were low during the first regime, lasting until the First World War. Many of today’s large global Swedish companies were founded during this time. The three following regimes are characterized by increasing taxation, which is likely a partial explanation for the reduced entrepreneurial activity (e.g., in the form of innovation and the establishment of major companies) until the late 1980s. The final tax regime follows the great tax reform of the early 1990s, when effective taxes decreased substantially. While it is difficult to establish causal relationships, the fact that this development coincides with what can be labeled an entrepreneurial renaissance is unlikely to be a coincidence.
Read HFI Notes no. 3 here.