Entrepreneurial risk taking and capital tax design

People who work for their own businesses accounted for 20% of the UK's workforce in 2019 and were the fastest growing part of the UK's labour force in the prior two decades. Ensuring that people with good ideas start businesses and invest matters for economic growth, which drives overall living standards. But starting a business is often risky, even in normal times (self-employment declined during the pandemic), and business owners may not capture all of the societal benefits to their ventures ('spillovers'). Risk and spillovers can mean that new business investment is lower than would be ideal from society's perspective.

Governments often try to encourage entrepreneurship by taxing business owner-managers at lower rates than employees. The differences can be very large: a business owner-manager taking income as capital gains faces a 28% tax rate, compared with the top overall marginal rate on wage income of 53%. This encourages tax avoidance: people running their own companies can (and do) pay themselves in dividends or capital gains to avoid higher labour income tax rates. Low capital tax rates also worsen inequality because business incomes are skewed to the top of the income distribution: 30% of the income of the top 0.1% comes from business ownership, compared with just 10% for those outside the top 1%.

The overarching aim of this research is to improve the design of the tax system to better alleviate the sources of under-investment in start-ups and small businesses, while reducing tax avoidance and inequality. Achieving this requires creating new datasets, developing state-of-the-art modelling techniques and actively engaging with policymakers.

We will use tax records to create the first dataset on the universe of UK business owner-managers (the self-employed and those who own and run companies) over the past 20 years. This will allow us to provide the most comprehensive description to date of who starts UK businesses, how individuals' incomes evolve...