Document Type

Working Paper




Metropolitan Studies Program Series


We thank Esther Gray, Mary Santy, Ann Wicks, and Jodi Woodson for their aid in preparing the manuscript. We are grateful to Jason Cummins, Martin Feldstein, William Gale, William Gentry, Daniel Hamermesh, Bo Honoré, David Joulfaian, Leslie Papke, Yoram Weiss, two referees, and seminar participants at Baruch College, Boston College, Brigham Young University, George Mason University, The National Bureau of Economic Research, Princeton University, Syracuse University, the University of California at Santa Barbara, the University of Kentucky, the University of Maryland, and Vassar College for useful comments on an earlier draft.


Economic Policy | Economics | Public Affairs, Public Policy and Public Administration | Public Policy


This paper investigates the effect of entrepreneurs’ personal income tax situations on their use of labor. We analyze the income tax returns of a large number of sole proprietors before and after the Tax Reform Act of 1986 and determine how the substantial reductions in marginal tax rates associated with that law affected their decisions to hire labor and the size of their wage bills. We find that individual income taxes exert a statistically and quantitatively significant influence on the probability that an entrepreneur hires workers. Raising the entrepreneur’s “tax price” (one minus the marginal tax rate) by 10 percent raises the mean probability of hiring workers by about 12 percent. Further, conditional on hiring employees, taxes also influence the total wage payments to those workers. The elasticity of the median wage bill with respect to the tax price is about 0.37.


0732 507X

Additional Information

Metropolitan studies program series occasional paper no.193


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Creative Commons Attribution 4.0 International License
This work is licensed under a Creative Commons Attribution 4.0 International License.



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