THE INCOME TAX AND SELF-EMPLOYMENT

Abstract

In theory, the individual income tax is "general" in the sense that its impact is the same on returns from all types of employment. But in practice, certain features of the income tax suggest that incomes from self-employ ment are taxed at lower effective rates than wages and salaries. Empirical analysis of the determinants of self-employ ment activity by male workers is consistent with the hypothesis that rising income taxes induce labor to shift from wage and salary jobs into self-employment. The presence of tax differentials between wage and salary workers and the self-employed diverts labor from its most efficient allocation and generates an excess burden that makes the welfare cost of the income tax larger than previously estimated.