The Unobserved Returns to Entrepreneurship: Evidence from the PSID

Abstract

This paper resolves a longstanding empirical puzzle: that most entrepreneurs persist despite lower initial earnings and earnings growth. I hypothesize that consumption is a better measure of self-employment returns than reported income, suffering from fewer biases. Using 38 years of longitudinal data, I find that individuals in self-employment report earning 26.2% less, but consume 4.5% more. This increase comes from persistence, with consumption growing 0.85% more annually in self-employment. Increased consumption is not offset by lower savings or higher uncertainty, and those who fail in self-employment do not incur observable losses in lifetime consumption. Lastly, individuals work more in self-employment.

Keywords: Entrepreneurship Labor Self-Employment Consumption Expenditures Tax Underreporting

JEL Classification: E2, E21, E24