Are Changes of Organizational Form Costly? Income Shifting and Business Entry Responses to Taxes

Abstract

Drawing on administrative panel data covering the full population of business owners in the UK, I study the effects of differential tax liabilities across organizational forms on business entry and on income shifting. I find that a 10% increase in savings from incorporation leads to a 1.7% increase in the number of new business owners. However, higher entrepreneurial entry is offset by income shifting – increasing the hazard rate of incorporation of the existing self-employed by up to 2.3% for a 10% increase in tax savings. I show that despite large tax savings from incorporation (exceeding 10 pp in some years), a substantial proportion of business owners fail to incorporate, suggesting that income shifting through incorporation is not the primary avoidance channel for the self-employed.

Keywords: Incorporation, Organizational Form, Avoidance, Income Shifting, Compliance Cost

JEL Classification: G32, G38, H24, H25, H26, L22