Abstract: Paper No. 193
Income Taxes and Entrepreneurs' Use of Labor
Robert Carroll, Douglas Holtz- Eakin, Mark Rider, and Harvey Rosen
July 1998
This paper investigates the effect of entrepreneurs' personal income
tax situations on their use of labor. We analyze the income tax returns of
a large number of sole proprietors before and after the Tax Reform Act of
1986 and determine how the substantial reductions in marginal tax rates
associated with that law affected their decisions to hire labor and the
size of their wage bills. We find that individual income taxes exert a
statistically and quantitatively significant influence on the probability
that an entrepreneur hires workers. Raising the entrepreneur's "tax
price" (one minus the marginal tax rate) by 10 percent raises the
mean probability of hiring workers by about 12 percent. Further,
conditional on hiring employees, taxes also influence the total wage
payments to those workers. The elasticity of the median wage bill with
respect to the tax price is about 0.37.
A revised version of this paper appears in Journal of Labor
Economics, Vol. 18, No. 2, April 2000, pp. 324-351.
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