Can state tax policies be used to promote entrepreneurial activity?

Despite a recent flurry of empirical research on the effects of taxes on small business activity, state-level taxes faced by entrepreneurs have been overlooked by most of the existing literature. Using a 50-state panel of tax policy information spanning the years 1989 through 2002, our analysis reveals that state tax policies generally do not appear to have quantitatively important effects on entrepreneurial activity. When we find statistically important effects, we find that higher individual income tax rates, the existence of a state-level estate, inheritance or gift tax, and a higher weight on the sales factor in the state corporate income tax apportionment formula all slightly reduce a state’s share of the national entrepreneurial stock. Results also indicate that states with more progressive personal income tax structures and states that have more aggressive corporate income taxes through the imposition of a combined reporting requirement both tend to have slightly higher entrepreneurship rates. The composition of state tax portfolios is not found to be a significant determinant of state entrepreneurship.