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Abstract
The United States federal tax code is notoriously complex, and although there are many estimates of the costs of that complexity, there is little discussion of the effects of complexity on entrepreneurial activity. I use the word count of tax codes as a proxy for complexity to learn how complexity impacts entrepreneurship across the U.S. states. I find that a standard deviation increase in tax code length is associated with up to a 5 percent decline from the mean in business entry and exit rates. I conclude that tax code complexity has a negative impact on the dynamism of economies.
JEL Codes: K34, H32, L26, M13, O43
Keywords: tax code complexity, entrepreneurship, business exit, business entry
I. Introduction
The federal tax code in the United States is incredibly complex. However, little attention has been paid to complexity' in states' tax codes. Gupta and Mills (2003) estimate that the 1,000 largest public firms face state tax compliance costs of around $300 million and federal tax compliance costs of around $1 billion. These compliance costs represent approximately 2.9 percent and 1.4 percent of their state and federal tax expenses, respectively (Gupta and Mills 2003). The cost of tax code complexity likely generates economies of scale due to expertise or experience in navigating required paperwork, so that the relative importance of these costs is likely higher for new ventures. Dealing with a complex tax system may be outsourced to an accounting firm, but it still adds a fixed cost that increases the minimum efficient scale of a business.
What is not clear is how large an impact such complexity has on entrepreneurial activity. Complex tax codes affect American entrepreneurs from the federal level down to the local level and add compliance costs at each step. This study will examine the effect of state tax code complexity. Data collected for this research suggest that such complexity is a fraction of that at the federal level, with the Internal Revenue Code estimated to be over 3.4 million words (Walker 2013). Because this study allows a cross-sectional comparison, it will offer insight into the economic effect of tax code complexity. The findings of this study suggest that tax code complexity at the state level matters, and by extension...