Abstract: Paper No. 192

Entrepreneurs, Income Taxes, and Investment

Robert Carroll, Douglas Holtz- Eakin, Mark Rider, and Harvey Rosen

July 1998 

This paper investigates the effect of entrepreneurs' personal income tax situations on their capital investment decisions. We examine the income tax returns of a sample of sole proprietors before and after the Tax Reform Act of 1986 and determine how the substantial reductions in marginal tax rates for the relatively affluent associated with that law affected their decisions to invest in physical capital. We find that individual income taxes exert a statistically and quantitatively significant influence on investment decisions. In our sample, a 5 percentage point increase in marginal tax rates would reduce the proportion of entrepreneurs who make new capital investments by 10.4 percent, and decrease mean investment expenditures by 9.9 percent.

A revised version of this paper appears in Conference, Does Atlas Shrug? The Economic Consequences of Taxing the Rich. New York: Russell Sage Foundation, 2000, pp. 427-455.