Taxation and Entrepreneurship: Panel Data Evidence from SAARC Countries

Abstract

Entrepreneurship plays a vital role in the economy; there is no well-established evidence on how taxes affect start-up activity in SAARC countries. We examine the effects of the personal income tax rate on self-employment using the annual time series data from the SAARC countries for the period 2015 to 2019. According to the differenced-GMM model developed by Arellano and Bond [1], the personal income tax rate has a statistically significant and negative impact on self-employment rate. The result shows that a one percentage point increase in the personal income tax rate is associated with a 0.03 percentage point decrease in the self-employment rate, while other variables being constant. The results confirm that the negative incentive effect dominates the causation between personal tax rate and self-employment for this panel. This suggests that in SAARC countries, there is still a negative correlation between personal income tax rates and entrepreneurship. According to the Robustness tests, an increase in the personal income tax rate discourages entrepreneurship as measured by the number of new limited liability companies and business density rate, two alternative measures of entrepreneurship. An important implication of our result is that a reduction in personal income tax rate encourages self- employment. Our findings are significant in designing the tax policy in SAARC countries. Removing tax barriers for entrepreneurs would boost the dynamic of SAARC countries while also making the tax structure more neutral, efficient, and simple for all taxpayers.