Tax Policy and Firm Entry and Exit Dynamics: Evidence from OECD Countries

In this paper we study the effects of reforms to corporate and personal income taxation on the rate of firm entry and exit using industry data for 19 OECD countries from 1998 to 2005. Using a difference-in-differences approach to correct for endogeneity bias we find that increases in corporate taxation affect entry but not exit. This drop in entry is statistically and economically significant, representing a reduction of 6.3% of pre-treatment levels. A number of placebo and falsification tests suggest that our inferences are not confounded by other factors. For example, the results are specific to the mediating variable used, and our identification strategy is sharpened by a triple-difference specification which rules out alternative fiscal explanations and an instrumental variables technique that leverages instruments found to influence tax policy by the political economy literature. The effects of personal taxation depend upon the marginal tax rate that is altered. Increases in marginal tax rates applied at low income levels negatively affect entry and positively affect exit, whereas marginal tax reforms at higher income levels have the opposite effect.