How Much Do Taxes Discourage Incorporation?




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    • Both authors are from the University of Michigan and NBER. We thank Laura Kalambokidis, Linda Burilovich, Sharon Parrott, David Eaton, Tracy Hudson, Steve Pincus, Bill Boyle from the IRS, and especially Jane MacKie-Mason for assistance in creating the data set for this article. Yong Yang provided superb econometric support. We received helpful comments from a referee as well as from Jane Gravelle, Joel Slemrod, and Mark Wolfson and seminar participants at NBER, Stanford Business School, Hoover Institution, UC Berkeley, UCLA, Rochester Business School, Toronto, and Michigan. Financial support for the data collection was provided by the Office of Tax Policy Research and the Rackham Graduate School at the University of Michigan. The first draft of the article was written while MacKie-Mason was a National Fellow at the Hoover Institution. Previous versions of this article were circulated with the title “Taxes and the Choice of Organizational Form.” We gratefully acknowledge financial support from National Science Foundation grant SES-9122240.


The double taxation of corporate income should discourage firms from incorporating. We investigate the extent to which the aggregate allocation of assets and taxable income in the United States between corporate and noncorporate firms responds to the size of this tax distortion during the period 1959–1986. In theory, profitable firms should shift out of the corporate sector when the tax distortion is large, and conversely for firms with tax losses. Our empirical results provide strong support for these forecasts, and imply that the resulting excess burden equals 16 percent of business tax revenue.