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Wednesday, December 30, 2009

State Taxes Don't Matter Much to Entrepreneurship

The Small Business & Entrepreneurship Council made news this month by ranking South Dakota tops again on its Small Business Survival Index. As I have noted previously, the SBEC's index is more of an ideological wishlist than an analysis of actual small business performance.

The SBEC report also faces disagreement from one of the very experts it cites. To support his index's assumption that small businesses will thrive in states with low taxes, SBEC chief economist Raymond J. Keating (not a Ph.D.) cited work co-authored by Donald Bruce (a Ph.D.) that found decreases in marginal tax rates "might lead to increases in entrepreneurial entry and better chances of survival" (Bruce and Gurley, 2005, p. 24). Ignored by Mr. Keating is Dr. Bruce's finding in the same paper that "higher average tax rates on entrepreneurship income might actually increase the probability of entry" (p. 24).

Keating also ignores a November 2006 paper co-authored by Dr. Bruce with John Deskins for the Small Business Administration Office of Advocacy ("State Tax Policy and Entrepreneurial Activity"). To the good for Keating and the SBEC, Bruce and Deskins conclude that "Higher top tax rates on individual income, higher sales tax rates, and the existence of state-level inheritance or gift taxes all tend to slightly reduce a state’s share of the national entrepreneurial stock" (p. 2). They also find an apparent negative correlation between larger state and local governments and entrepreneurial activity (p. 22).

But Bruce and Deskins also knock at least a couple legs out from under the assumptions of Keating's index:
  • "...top marginal state tax rates on corporate and individual income do not have statistically significant effects on state entrepreneurship rates..." (p. 2).
  • "...states with higher sales tax rates tend to have higher entrepreneurship rates" (p. 2).
  • "The composition of state tax portfolios is generally not a significant determinant of state
    entrepreneurship rates" (p. 2).
  • "States with more progressive personal income taxes have slightly higher entrepreneurship rates" (p. 4).
  • "...taxes have statistically significant but very small and scattered effects on entrepreneurship rates. Consequently, they are likely to be ineffective in generating desired changes in entrepreneurial activity" (pp. 5–6).
Interestingly, over the period of the Bruce and Deskins study, 1989 to 2001, South Dakota was one of only five states that saw the self-employed percentage of its workforce decrease (Bruce and Deskins, 2006, Table 1, p. 34). Even with our low-tax-no-tax policies and the 1990s boom, South Dakota saw the percentage of workers doing their own thing go down.

Bruce and Deskins's work shows the fatal flaw in Keating's report. The "Small Business Survival Index" does not measure the actual survival of small businesses; it advocates a specific anti-tax agenda which research shows does not have a big impact on small business activity.

In other words, Keating and the SBEC are more concerned with ideology than with what really works.


  1. The people who would know most about what "really works" would, I suppose, be the ones who have fought the small-business survival fight in real time.

    Has anyone polled them to find out what factors they consider most important to their success or failure?

  2. Steve Sibson12/30/2009 6:12 PM


    Did you read the conclusion:

    "Rather than attempt to target tax breaks to small
    businesses, states should focus on traditional tax reforms involving lower tax rates, broader tax
    bases, and simpler tax systems that will create a more productive tax environment for small
    businesses, large businesses, and individuals alike."

    Your post is a pile of BS, contrary to your con-artist presentation, the conclusion is lowering tax rates, simplifying,and broadly applied tax reforms are good for every body. Stop with the tricks, it is not constructive. I really feel sorry for your students, they must be getting a real indoctrination, instead of an education.

  3. Stan: Folks have polled business owners about the factors they consider important... and, as this report points out, that's somewhat problematic, as respondents have a tendency to over-report the importance of tax breaks, out of "solidarity" with business/political interests and a desire to see the study confirm their own political bias (see p. 23).

    Steve: Yes, I did read that conclusion. Did you notice the line about broadening the tax base? That means getting taxes from more people. Sounds like we're even there. And I have no problem with a simple tax code. You know I've advocated a simple income tax for South Dakota: "Multiply your income by 7.2%, send to Pierre." Less accounting costs, more resources for doing business. But we also need to pay those taxes to pay for the public goods that make business possible. More to come....

  4. ... and indoctrination? Come now, Sibby. Some day when I win full-bird professorship, I'll invite you to team teach a course with me. Then we'll see who gets schooled. ;-)

  5. Steve Sibson12/30/2009 9:02 PM

    "Multiply your income by 7.2%"

    Cory, you are leaving out the "lower rate" part. The key is to lower the spending first, then lower the rates. And "public goods" too often are "special interest subsidies". And note that you even stated sales taxes were better, so lets work on budget cuts, eliminate property taxes, and then set a flat sales tax that applies to all goods and services.

    And we should team teach a tax policy class. I am very sure you will learn more than the students.

  6. If the legislature of this state passes a law forcing me to take a 7.2-percent pay cut, which a 7.2-percent income tax would in effect do, then I'll be gone to Wyoming before the law goes into effect.

    Tax-mongers, read Scott Munsterman's book and take note. Make the yoke too tight, and the oxen will revolt. Or, in my case, break loose and run from you.

  7. To soften my previous comment just a wee bit: I read your income tax proposal, Cory (a link appears on this blog Web site, for those who might want to look at it). You advocate repealing every existing tax before imposing the income tax. Great idea. But come now, honestly. Do you think the state, counties, and municipalities could ever agree on such a thing on a permanent basis?

    I've seen the world from the point of view of an academic, and also from the point of view of an entrepreneur.

    As an academic, I can see the idealism on the left, and I sympathize with it to a certain extent; but I do not want academics running this country, any more than I would want the captain of the aircraft on which I travel to have learned all she knows from books.

    As an entrepreneur, I can see the hard-nosed pragmatism in the center and on the right, and I identify more with it than with the academic side; these people are the components in the engine that makes this country great.

    Our government needs more small-business owners in the legislative and executive branches at all levels, people with bloodied noses, people with bruised knuckles, people with tear-stained faces from the battles they have fought with fickle fate, ridiculous red tape, and a pervasive, maddening, general human withering of the will.

    As for business owners "having a tendency to over-report the importance of tax breaks, out of 'solidarity' with business/political interests and a desire to see the study confirm their own personal bias" ... My God, Cory! Words fail me! You have hung yourself with your own rope!

    Aw, heck. Enough ranting from me. Happy new year!

  8. And happy new year to you, Stan!

    I agree, Stan, that we need pragmatism to make things work. President Obama drives me nuts with his preference for pragmatism over idealism (e.g., health insurance reform), but he also gets more bills passed than I ever would.

    Still, we need idealists to pull practical compromises a little closer toward the utopian good we can envision. Our legislature already has lots of farmers and businessmen you rightly respect; we need academics and idealists to balance them out, to dream, to challenge the practical "what is" with the aspiring "what if".

  9. Of course, Steve—police and roads and schools are just subsidies for special interests.

    And I always learn at least as much as my students when I teach.

  10. Cory,

    That was irresonsible and not constructive. We have already covered the difference between anarchy and limited government. And while most of your open minded students would learn from discussing the differences, you have proven to be one who will probably never get it. So that is why your students would learn more than you.

  11. "Our legislature already has lots of farmers and businessmen you rightly respect; we need academics and idealists to balance them out, to dream, to challenge the practical "what is" with the aspiring "what if"."

    Do you ever listen to yourself? That comment is dripping with arrogance!

    Entrepreneurs embody the balance between the practical "what is" with the aspiring "what if".

    Entrepreneurs are the engine that drive this economy. They are unjustly saddled with regulation and taxation. I speak with first-hand experience. I had to shutdown my company's operations directly due to the effects of government taxation and regulation. I will not bother you with the details, as they would likely not fit your wordview, and be summarily dismissed. I choose not to waste your time, nor mine.

    Any reasonable actions that would make entrepreurship easier and more affordable should be forstered.

    Those that can, do; those that can't, teach.

    Jason Bjorklund

  12. Read again, Jason. Did you catch the part of the line you quote where I say Stan "rightly" respects businessmen?

    I don't need to denigrate any particular person or profession to make my case. I make no such "arrogant" claim that my profession is more socially valuable or morally upright than anyone else's. I called for balance. Academics and idealists are as essential to civic discourse and social progress as blue-collar laborers, truck drivers, and business owners.

    Of course, those who teach make it possible for everyone else to "do". We all depend on each other.


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