Conference on Entrepreneurship and Economic Growth

Supported by the Ewing Marion Kauffman Foundation
Manuel Adelino and David T. Robinson, Organizers
October 14-15, 2016

Entrepreneurship and State Policy

E. Mark Curtis and Ryan A. Decker provide empirical evidence for how corporate taxes, minimum wages, and personal tax rates impact levels of startup activity.

Understanding the determinants of entrepreneurship is vitally important. Consider some of the key contributions entrepreneurship makes to the economy: Startups are responsible for a disproportionate share of newly created jobs, they play a large role in the speed with which economies recover from recessions and they account for an outsized share of innovations that spur technological progress and economic growth. In addition, entrepreneurship in and of itself is a highly valued occupational choice for many people.

Given this importance, many have expressed concern that entrepreneurship rates in the United States have been declining steadily in recent decades. The decline is stark, but the overall trend masks considerable variation in entrepreneurial outcomes at the state level. Entrepreneurial activity differs significantly across states, and the observed decline in startup activity (see figure) is far from uniform.

These facts raise the question of whether policymakers have the ability to influence entrepreneurial activity. This research explores the role of states' corporate tax rates, minimum wages, and personal tax rates in fostering or dampening entrepreneurship.

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Given that potential entrepreneurs carefully consider the costs of doing business, increased taxes and labor costs may discourage them from undertaking an already risky venture and may also reduce their growth after entry. Past research has suggested that startups are particularly sensitive to economic shocks relative to incumbent firms. Importantly, though, these different policies might be expected to have different effects: Business taxes are essentially imposed on profits, while a minimum wage is a cost imposed on labor demand. Data limitations and scarcity of plausibly exogenous policy variation have made it difficult for economists to study the effect of various policies on startup activity.

Determining the effect of these government policies is no easy task. States may choose their tax rates in part based on their current level of economic activity. Reverse causality will occur if states with weaker and less dynamic economies reduce tax rates in an attempt to spur new business activity. Conversely, states may be more likely to increase taxes when they know economic conditions are strong and businesses are likely to enter regardless of policy. For example, California and New York have both high taxes and high rates of entrepreneurship. However, it is unlikely that these statesÂ’ high taxes caused the higher levels of entrepreneurship.

The researchers use newly available data from the Quarterly Workforce Indicators, a dataset that contains detailed information on startup firms (defined as less than two years old) at the county level. The dataset contains startup firm employment levels, employment growth, job creation and job destruction. They employ a border discontinuity method that compares contiguous counties that straddle a state border. Counties that border each other are likely to be similar in a number of dimensions. Their strategy tests whether, for their measures of entrepreneurial activity, changes in within-pair differences emerge following changes to state policy that impact one of the counties in the pair but not the other. They examine the period 2000-2013, during which states made numerous changes to corporate tax rates, minimum wage laws, and personal tax rates.

Using this border discontinuity method, they discover that an increase in a state's top corporate tax rate of one percentage point led to a decrease in startup firms' employment of 3.6 percent, with much smaller effects on older firms. They also find that increases in the minimum wage result in declines in employment growth for startup firms, and that personal tax rates have no discernible impact on startup activity, despite the fact that many young firms are organized as pass-through entities for which profits are typically taxed at personal rates. Additional tests demonstrate that the effect of corporate tax rates reflects a reduction in overall entrepreneurial activity rather than simply a reallocation of activity across the state border, while the minimum wage result appears to reflect cross-border reallocation.

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