NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Income Taxes and Entrepreneurs' Use of Labor

Robert Carroll, Douglas Holtz-Eakin, Mark Rider, Harvey S. Rosen

NBER Working Paper No. 6578 (Also Reprint No. r2265)
Issued in May 2000
NBER Program(s):   PE

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.

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Document Object Identifier (DOI): 10.3386/w6578

Published: Journal of Labor Economics, vol. 18, no. 2, pp. 324-351, 1999.

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