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This paper studies the effects of income taxation on entrepreneurship,
empirically and in a structural macro model with entrepreneurial
choice. Combining state-level tax data with household
and firm data we document that higher and more progressive
taxation has a strong negative impact on entrepreneurial activity
across time and space. To explain this relationship and to evaluate
the impact of taxation on output and welfare, we develop
a life cycle, incomplete markets model of the labor market with
entrepreneurial choice. The model generates elasticities of entrepreneurship
to taxation that are similar to those found in the
empirical analysis.
