Taxes and entrepreneurial risk-taking: Theory and evidence for the U.S.

How does the tax law affect individual incentives to engage in entrepreneurial risk taking? We first show theoretically that taxes can affect incentives due to differences in tax rates on business vs. wage income, due to differences in the marginal tax rates faced on losses vs. profits through a progressive rate structure and through the option to incorporate, and due to risk sharing with the government. We then provide empirical evidence using U.S. individual tax return data that each of these aspects of the tax law have clear effects on individual behavior, and together have had large effects on the amount of entrepreneurial risk taking.