According to today’s Wall Street Journal (June 17, 2008), Barack Obama “proposes eliminating capital gains taxes on start-up companies ….” While the Journal points out the obvious problem with this policy idea – that the tax lawyers will have every company in America defined as a start-up – it missed the subtler problem.
Cutting taxes on start-up companies will encourage people to create more new businesses. But do we want more of the average start-up to be formed?
I don’t think so. We’d want more start-ups if new companies were more productive than existing companies. But they’re not. A study by John Haltiwanger, Julia Lane, and James Speltzer, in the American Economic Review: Papers and Proceedings, showed that firm productivity increases with firm age. So if we encourage people to start new firms instead of working for existing firms, we are creating an incentive to decrease productivity.
The negative effect of stimulating firm formation can be seen in aggregate economic statistics. In an article published in Labour Economics, economist Danny Blanchflower showed that the correlation between self-employment rates and economic growth in the 19 OECD countries from 1975 to 1996 was negative. And when differences between countries are controlled, the data from the Global Entrepreneurship Monitor indicate that increases in total entrepreneurial activity are associated with decreases in GDP growth.
I’m not sure we’d be doing the entrepreneurs themselves any favors either. When governments intervene to encourage the creation of new businesses, they stimulate people to start new companies disproportionately in competitive industries with lower barriers to entry and high rates of failure. And the entrepreneurs who run those businesses typically earn less money and have worse benefits than they would have earned had they remained working for someone else.
So perhaps we would be better off letting the market work and not provide extra incentives for people to start businesses.
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About the Author Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of eight books, including Illusions of Entrepreneurship: The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By; Finding Fertile Ground: Identifying Extraordinary Opportunities for New Ventures; Technology Strategy for Managers and Entrepreneurs; and From Ice Cream to the Internet: Using Franchising to Drive the Growth and Profits of Your Company.