TAXATION AND PUBLIC POLICY TOWARDS SMALL FIRMS A REVIEW

2 INCOME TAXATION G4S AND US CITIZENS
INFORMATION PENSIONS TAXATION ANNUAL ALLOWANCE HM REVENUE
INFORMATION PENSIONS TAXATION LIFETIME ALLOWANCE HM REVENUE

3 THE POLITICAL ECONOMY OF TAXATION POSITIVE AND NORMATIVE
8 STATE OF NEW YORK DEPARTMENT OF TAXATION AND
ACT OF SEDERUNT (TAXATION OF JUDICIAL EXPENSES RULES) 2019

Taxation and Public Policy Towards Small Firms: A Review

Taxation and Public Policy Towards Small Firms: A Review

Francis Chittenden & Brian Sloan


Abstract


The favourable tax treatment of the self-employed and SMEs can only be justified on efficiency grounds if there is evidence that they provide spillover (external) effects to the rest of the economy that are not fully captured by these small “firms”. However, many countries have incomplete integration between personal and corporate tax systems. The resulting non-neutral tax structures are often inefficient, distorting the allocation of resources. Consequently, policy makers need to design tax policies for entrepreneurship to remedy market failures, while avoiding adverse side-effects. The paper concludes with suggestions about the characteristics of an optimal small business tax system.


Background


In the broad area of tax policy there is a range of literature from internationally respected authors that is relevant to small firms in advanced economies, including evaluations of policy designed to improve access to finance and also other tax policies such as R&D tax credits, capital allowances and the effect of taxation on the rate of business formation and growth. The objective of this article is to assemble the findings of this diverse literature into a coherent review that presents arguments about the relevance of taxation to small business policy and the ways in which taxation might be used as part of public policy towards smaller firms in mature economic environments, whilst avoiding undesirable effects that distort commercial decision making.


As a starting point the findings of two papers are presented. Chen Lee and Mintz have argued that small firms in a number of OECD countries are subject to sub-optimal tax systems that do not address market failures that hamper the growth of small firms.1 These market failures are generally taken to include2: rewards for the externalities provided by small firms to the benefit of the wider economy that are not fully captured by small firms (e.g. with R&D expenditure); the need to provide tax breaks for small firms, on the basis of equity, i.e. fairness vis a vis other firms (for example because of the regressive costs of regulations); the need to stop the tax system from influencing business decisions, i.e. to make tax more economically efficient (for example to neutralize the tax advantages associated with debt financing; if there was evidence that capital market imperfections were leading to under-investment in small firms (because of the equity gap and the problem of credit rationing for entrepreneurs lacking collateral or a track record); if the level of taxation were constraining the willingness of entrepreneurs to take risks (for example because a very high proportion of their wealth is invested in just one venture). Chen Lee and Mintz conclude that governments should re-examine their tax systems and seek to remove the biases against small firms, providing doing so does not lead to the inefficient allocation of resources elsewhere in the economies concerned. However, these conclusions are contested. For example, Holtz-EakinError: Reference source not found, discusses the market failures that would justify public policies that favour small firms, as noted above, but concludes in every case that the tax system in the USA is an inappropriate mechanism for addressing these disadvantages. These arguments are examined here in some detail, drawing upon a range of literature relevant to the taxation of small firms.


The next section discusses general issues relating to the tax system that, despite their broad relevance, are important to public policy towards small firms. The taxation of business profits section reviews the literature on the efficiency and desirability of the profits base for taxation observed in most advanced economies and the implications of this tax base for small firms. The following section then considers public policy towards small firms, from a fiscal perspective, and examines a number of specific public policy issues concerning small firms. A discussion section brings together the diverse literature reviewed, particularly highlighting whether there is any justification for using the taxation system as a means to support public policy towards small firms. Finally the main arguments are drawn together into a conclusion and suggestions are made for a theoretically sound fiscal stance towards small firms.


General issues


A fundamental issue recognised in the literature is that the effectiveness of tax policy is dependent upon a broad base of support from citizens. As a consequence fiscal policy cannot be determined in isolation from the socio-political climate of the day.3 Whilst this statement may seem trite, in the literature relating to tax compliance and evasion research indicates the importance of broad political support to the successful working of the tax system, because it is dependent upon very high levels of voluntary compliance by citizens, including business owners.4 Consequently taxpayers, the vast majority of whom are compliant, should be treated with respect by the tax authorities.5 Operating a tax system without that support would be very expensive, if not impossible. Conversely, when policies enjoy broad political support a wide range of tax rates and structures may be workable, e.g. in relatively low tax economies, such as the US, and high tax countries, such as Sweden.6


A second fundamental point is that, despite the popular appeal of the notion of Laffer curves7 where reductions in tax rates result in increased tax revenues, the literature shows that, from a historical perspective, tax incentives and reductions in tax rates have generally not been self-financing.8 However, it should be noted that Griffith et al predict that the R&D tax credit in the UK could be self-financing over the long term, because of the positive externalities associated with this form of investment expenditure.9


Proposals for major reforms to the structure of business taxes are made by a number of researchers. The pro-genitor of these ideas is the argument (now several decades old) that the most economically efficient tax base for businesses would be cash-flow.10 The more recent proposals are for a flat tax system in the US and the Ralph Committee proposals in Australia.11 Whilst governments may recognise the theoretical attraction of these tax systems, there is reluctance to engage in such radical reform. There appear to be two reasons for this. First, in practice the proposed taxes may be less straightforward than initially anticipated12 and secondly concerns exist about the level of tax revenues that might result13, partly because changes to the tax code may yield unanticipated opportunities for tax planning. The tax code should be designed to minimise tax planning activity by reducing opportunities and incentives to switch incomes from high to low taxable sources; alter the timing at which incomes are recognised or tax is payable; or move incomes from high to low tax bands, e.g. by avoiding thresholds.


Within these boundaries this paper attempts to synthesise findings from the literature on taxation relevant to public policy towards small firms, and to assemble this in a way that explores the possibility that an optimal system of taxation for small firms could be designed that is consistent with the broad theoretical underpinnings evident in the literature.


The taxation of business profits


Despite the lack of theoretical attraction referred to above, in advanced economies direct business taxes are presently levied on profits, in some cases adjusted in accordance with the tax code. One such adjustment relates to adding back accounting depreciation and then deducting “capital allowances” calculated in accordance with the rules of the tax authority. Bond, Devereux and Gammie are critical of the capital allowances system and argue that it does not offer adequate incentives to encourage investment, particularly in the presence of tax incentives to utilise debt as opposed to equity.14 The most elegant response to this has been the proposal of an “Allowance for Corporate Equity” (ACE).15 The ACE seeks to remove the tax incentives to use debt by allowing a deduction from taxable profits equivalent to an imputed interest charge based upon the value of equity in the balance sheet. Despite the theoretical attraction of this proposal only one reference to the adoption of an ACE in practice can be found in academic literature, and this was subsequently withdrawn by the Croatian government in 2001, some six years after its introduction. However, the reasons for abolition appear to have been driven primarily by political factors rather than valid criticisms of the economic efficiency of the ACE.16


In the context of small firms the distortion caused by the tax deductibility of interest (referred to above) may be of relatively less importance than for large firms because of the well-known fact that business owners wish to grow their enterprises from retained profits. This was first articulated by Bolton:17

“…what is required for the health of the (small firms) sector is an economic and taxation system which will enable individuals to acquire or establish new businesses out of personal resources and to develop these on the base of retained profits. Without this no institutional financing arrangement can preserve the small firms sector.”


It might be expected that this conclusion, reached over 30 years ago, would no longer be valid. However, more recent studies have confirmed that for the majority of (small) businesses retained profits remains the preferred source of finance.18


There are other pressures for change on the corporation tax system in particular, and these relate to international tax competition. Tax competition is probably a zero sum game because states suffering a loss of economic activities may have little choice other than to respond19, although there may be a time delay. However, there is little doubt that if countries can adopt a policy of low corporate taxes, at the same time as maintaining fiscal prudence, orderly labour policies and access to sophisticated industrial and consumer markets, there may be opportunities to attract foreign direct investment to the benefit of the economy as a whole, including the small business sector. The low corporate tax policies adopted by Ireland in the 1990’s is an example of such an approach.20


The prospect of tax competition21 together with the mobility of international capital has led some authors to suggest that taxes on business profits should be abolished altogether22 and replaced by consumption taxes.23 Indeed it is generally accepted that taxes on production, e.g. corporate taxes, are less economically efficient than taxes on consumption, i.e. indirect taxes.24 However the size differential of these effects is less clear. Engen and Skinner argue that tax structures are important to economic growth, whilst Branson and Knox-Lovell state that tax rates are six times more influential than tax structures.Error: Reference source not found In practice it seems unlikely that taxes on business (especially corporate taxes) will be abolished unless the US were to adopt such a radical policy and, if they were, other avoidance measures would need to be put in place to cope with the tax planning opportunities arising from the wide tax differential between personal and business taxes.Error: Reference source not found, Error: Reference source not found The high rate of new business incorporations evident in the UK as a consequence of the introduction in 2002 of the zero per cent rate of corporation tax on profits up to £10,000, is an example of the behavioural response to such a tax differential that caused the measure to be withdrawn in April 2006.25


Public policy towards small firms


Do taxes restrain entrepreneurial activity?


Consideration of this issue is important for economic prospects as there is general agreement that tax policies do affect profits growth and the size of economies in a variety of ways26, for instance through the impact on incentives to create wealth, on tax planning efforts, on compliance and evasion and on the allocation of resources between the public and private sectors. A number of articles explore the extent to which entrepreneurship is constrained and whether tax policy has a role to play in minimising any adverse effects.


Some opening comments are appropriate to this discussion. First, entrepreneurial behaviour is difficult to monitor, as a consequence most studies use self-employment as a surrogate measure. This is unsatisfactory as it is acknowledged that self-employment encompasses a variety of forms of economic activity, including lifestyle businesses and “quasi-employment”.27 In addition it should be noted that the form of “entrepreneurship” considered here is that identified by Knight, where the entrepreneur is also the provider of capital.28 This contrasts with the Schumpeterian view where investors other than the entrepreneur provide the resources.29 Today the Schumpetereian entrepreneur is perhaps an intrapreneur. This form of economic activity is not considered here, indeed relatively little is known about its scale or impact.


Gentry and Hubbard conclude that the tax system influences the numbers of people adopting self-employment, and in a study of the US these authors argue that tax differentials could either encourage or discourage the adoption of self-employed status.30 However, taxation is only one of a series of influencing factors affecting this choice. Other relevant issues include the desire to be “your own boss”31, the availability of a safety-net, such as alternative job opportunities, and the presence (or absence) of a sense of financial security.32


Do taxes exacerbate the financial constraints on entrepreneurship?


Turning to the financial constraints on “entrepreneurship”. There is considerable debate about whether these financial constraints exist. Many academics argue that financial constraints on entrepreneurship do not exist; however there is also a strong body of literature that opposes this view.33 With regard to the argument that they do not exist, the argument follows that because it is impossible for banks to differentiate between businesses with good or poor prospects, some poor proposals are funded and some strong ones rejected. If banks have to rely upon collateral security, because they lack evidence on which to judge the commercial prospects and acumen of business founders, they may either over or under invest. Parker’s recent work is tellingError: Reference source not found, as he is the first economist to present a theoretical proposition that both credit rationing and under-investment can occur simultaneously. Previously it was thought that because it is impossible to differentiate between new business proposals that will be successful and those that will not, even in the presence of credit rationing, over-investment occurs. However, recognising that entrepreneurs are liquidity constrained is not the same as arguing that there is market failure in the provision of debt finance or that the tax system is necessarily the best mechanism by which to address these liquidity constraints.


On this latter point researchers are once again divided with BoltonError: Reference source not found and ParkerError: Reference source not found arguing that the tax regime may be an appropriate policy vehicle to alleviate the financial constraints on entrepreneurship. Bolton advocates incentives for business owners to grow their businesses from retained profits and Parker suggests using the tax system to improve individual’s choices between employment and self-employment and thus, indirectly raising the quality of business propositions seeking finance. In contrast Holtz-Eakin acknowledges the existence of capital market imperfections but concludes that the tax system is not an appropriate policy instrument as, in this case, market failure results from lack of information about business prospects.Error: Reference source not found


However, none of these arguments are entirely satisfactory from a policy perspective. BoltonError: Reference source not found reported at a time when levels of personal wealth and the fiscal environment were very different, possibly reducing the strength of his arguments today, and Parker acknowledges that his work is novel and requires further developmentError: Reference source not found. Holtz-Eakin argues that the tax regime is likely to prove ineffective in addressing liquidity constraints even though he acknowledges that business owners are in the best position to judge the commercial prospects of their businesses.Error: Reference source not found Keuschnigg also considers that tax reliefs could be offered to hands-on venture capitalists to enable the expansion of their managerial resources and so increase the volume of investments made.34 However, this proposal appears to assume that there are few constraints on the supply of experienced venture capital managers, a condition that some would find difficult to accept, at least in the short-term.


The authors conclude that in the literature the issue of whether new businesses are liquidity constrained remains unresolved. However, this is a somewhat different issue from whether the tax regime reduces the availability of finance for the expansion of established businesses. On this the evidence is more clear cut, with examples of both theoretical support and empirical evidence being found in the literature.35 Whilst these studies do not quantify the extent to which the availability of business finance is reduced by taxes, Poutziouris et al find that 45 per cent of business owners claim they would seek to earn additional profits to take advantage of a £5,000 tax free allowance for business profits and 29 per cent claimed that they would, if necessary, reduce their personal drawings from the business in order to utilise such an allowance.36 Poutziouris et al provide a theoretical framework that explains recent UK experience that the tax system strongly influences the behaviour of business owners in terms of the profits that they declare for tax purposes.


Taxes and the choice between employment and self-employment


With the issue of the role of the tax system in helping to alleviate the financial constraints on entrepreneurship partially unresolved, the discussion turns now to a consideration of the dynamics that influence the choice of employment or self-employment. Here a number of co-incidental factors appear to be at work. Chen et al find that in a survey of OECD countries the self-employed face lower levels of taxation than employees and that this influences the employment / self-employment decision.Error: Reference source not found In the UK Redston discusses the combined effects of the favourable tax treatment of the self-employed, particularly with regard to lower levels of social security taxes, and the rising levels of employment regulation.37 As a consequence in the UK incentives have increased for both individuals and businesses to contract on the basis of self-employment rather than employment. These conditions were probably exacerbated in recent years by the zero per cent rate of corporation tax making self-employment through a company even more attractive. The resulting growth in the numbers of newly incorporated businesses has now resulted in the zero per cent rate of corporation tax being withdrawn, as referred to earlier.38 Her Majesty’s Revenue and Customs (HMRC) also appear reluctant to apply IR3539 in a significant number of cases.40 In addition the widening gap between National Insurance Contributions (NICs) paid by both employees and employers compared with the self-employed is reducing the attractiveness of employment.Error: Reference source not found


In some OECD countries, such as France and Germany, over the last few years the push factors towards self-employment have been operating at relatively high levels because of sluggish economic growth and strong employment regulation, in others such as the US and UK the pull factors associated with independence, financial security in the form of rising housing equity or life partners in secure employment have probably increased the incentives to become self-employed.41


Taxpayer compliance


Moving now to compliance issues, a number of papers make it clear that the tax system is heavily dependent upon the voluntary compliance of tax-payers. Andreoni, Erard and Feinstein show that in the US actual compliance levels are far higher than economists can explain. Voluntary compliance results in excess of 83 per cent of taxes being declared and paid on time, with enforcement activities contributing only another 3 per cent to total gross receipts. Enforcement tactics are relatively ineffective, with audits thought only to detect about 50 per cent of unreported income and having an uncertain impact on ongoing compliance levels. However, the threat of audit, coupled with citizens’ generally weak knowledge of the (low) probability of investigation, are seen as effective motivations for compliance.42


Secondly, it is recognised that a very high proportion (84 per cent) of those who have the opportunity to evade do so, to some extent43, making industry sector agreements and deductions of tax at source particularly effective in promoting compliance.44 People whose incomes cannot readily be checked, such as some types of self-employed individuals and small businesses, are particularly likely to evade.Error: Reference source not found This is a tricky issue that is influenced by conformity to social norms, that are usually assumed to support honest behaviour. However once the decision to evade is taken, the extent of evasion jumps to its optimal level bearing in mind the risk and perceived consequences of discovery.45 From a public policy perspective a balance of approaches is probably required, including sustaining uncertainty in the minds of taxpayers about the threat of audit, whilst promoting honest reporting through the tax system being seen to be equitable and fair across different social groups. Voluntary compliance is also promoted if the taxpayer reacts favourably to government policies and activities46 and taxpayer compliance costs are minimised.47


Where professional advisers are involved tax compliance for checkable items is higher, but perceived as more aggressive where incomes cannot be checked. Investigations of the clients of professionals detect less evasion than where no advisor is involved.48 The role of professionals is recognised to be influential both in reducing detectable evasion and informing clients of relevant tax policies that should influence their decisions.49


Discussion


The purpose of this section is to consider whether there is an economic case for the preferential tax treatment of small businesses. It is argued that the points presented below would provide valid reasons for the favourable policy treatment of small firms.50 However, on balance, Holtz-Eakin concludes that in the US, at least at the time of his analysis, the features that would justify favourable tax treatment for small firms are either not present, or that the tax system is an inappropriate means to address those particular market failures. The alternative view, that in some cases argues for the favourable tax treatment of small firms (for example in respect of retained profits used to fund growth) and in others through raising taxes to improve the neutrality of the tax system with respect to business decisions (i.e. by reducing the differential in social security taxes between the self-employed and employees) is presented here.


First, it is argued that public policy support for small firms would be justified if the presence of externalities provided by small firms bring benefits to the wider economy, but the rewards are not fully captured by small firms, e.g. if small firms were highly innovative, but the majority of the advantages accrued to other businesses who, because of their market power, were able to buy small firms or acquire their technology for less than its true worth.


The academic evidence reviewed here has shown that taxation affects the size of the economy and the number of new and small firmsError: Reference source not found and deters risk taking.51 Perhaps, the question is not whether tax policies could address these issues, but whether policies in support of small firm formation and growth can be effective without adversely distorting the workings of the wider market? The answer would appear to be that policy makers and some academics believe that, in certain specific circumstances, tax measures that favour small firms in a modest way are justified. For example, a number of countries including the US and the UK currently offer enhanced tax incentives for R&D investment, including both new and small firms, and it is believed these will be self-financing in the long-term.Error: Reference source not found


Second, public policy support for small firms would be justified if there were a need to provide policy support for small firms on the basis of equity, i.e. fairness vis a vis other firms. There could be a variety of causes52 but, one particular argument is that government places small businesses at a disadvantage because of the effects of regulations. It is known and generally accepted that the vast majority of the costs of regulation on business fall upon small firms.53 Indeed it can be argued that many forms of regulation observed in the UK and EU involve the transfer of resources from businesses to consumers, in a similar manner to direct taxation.54 Even experts sceptical of the economic contribution of small firms acknowledge that the disproportionate burden of regulation would be an appropriate justification for compensating tax allowances for SMEs.55


Third, support for small firms would be justified if there were a need to stop the tax system from influencing business decisions, i.e. to make tax more economically efficient. It is acknowledged, both in the UK and US, that decisions about legal form are influenced by tax rules.56 It appears that the tax system is not neutral in its impact on small business decisions and there is scope for improvements to the tax code in this respect. However, this would be unlikely to involve favouring small firms. Rather, as Chen et al and Sloan and Chittenden argue neutrality could be improved by raising taxes, especially social security contributions payable by the self-employed, bringing these closer to the levels payable by employees, taking account of the higher levels of risk faced by workers who do not enjoy the social protections offered by employment legislation. As far as possible the choice of employment or self-employment should be tax neutral.57


Fourth, support for small firms would be justified if there was evidence that capital market imperfections were leading to under-investment in small firms, e.g. because lenders were restricting the amount of finance provided to small firms. The existence of capital market imperfections is acknowledged, on balance, by the literature covered in this review. These imperfections are not caused by the lending policies of providers of debt finance but are the result of information asymmetries between entrepreneurs and investors or lenders.58 It is acknowledged that the best judges of a business’s prospects are the entrepreneurs themselvesError: Reference source not found; it is also well known that business owners wish to grow their businesses from retained profitsError: Reference source not found, Error: Reference source not found; and that taxes on producers are themselves economically inefficient.Error: Reference source not found, Error: Reference source not found The authors conclude that there is scope for the tax system to address this issue.


Fifthly, policy support for small firms could be justified if the level of taxation was constraining the willingness of entrepreneurs to take risks. It is acknowledged that owning a single business as the dominant investment in a person’s portfolio deters risk-taking.Error: Reference source not found Given that new business formations are in any case running at high levels the tax system does not need to encourage start-ups, indeed some economists argue that the quality of the business stock would rise if new firm formations were restrained.59 However, whilst business formation thrives on the risk-seeking or “skewness loving”60 predisposition of business founders, it is business growth that is particularly constrained because profits retained for re-investment are subject to taxation. Put simply, internally generated resources are the preferred choice of funding for established privately owned businesses and the tax system can directly influence the incentives facing business owners when deciding to retain profits for growth or to extract funds to enhance their personal lifestyles or diversify their risk position.61


Conclusions


Overall the authors concur with Chen, Lee and Mintz who conclude that many of the OECD countries reviewed in their analysis have incomplete integration between personal and corporate tax systems.Error: Reference source not found Consequently, especially where special tax provisions for the self-employed and SMEs exist, tax systems are not neutral and affect decisions regarding organisational form, corporate capital structure and dividend distributions. The resulting non-neutral tax systems are often inefficient, distorting the allocation of resources. The favourable tax treatment of the self-employed and SMEs can be justified on efficiency grounds where there are spillover (external) effects to the rest of the economy. Consequently, governments need to review the tax biases influencing the levels of entrepreneurship and favouring the self-employed and to design tax policies for smaller firms to remedy market failures, while avoiding adverse side-effects. Some of these policies will probably lead to increases in the taxation of certain business types, such as the self-employed, but others will lead to policies that favour small firms, e.g. in recognition of the regressive costs of regulation and in order to support risky (R&D) investments.


In reviewing tax policies towards small firms policy makers may find it useful to consider some theoretically sound features of optimal tax policies towards small businesses:


  1. Policies should be formed taking cognisance of the political context and public aspirations of the day.Error: Reference source not found For the tax system to operate effectively both fiscal policies and to some extent wider government policies must earn and sustain the respect of tax payers, in this case the small business community.62 Ideally such policies should also be stable, with little or no annual change.

  2. Tax rates should be as low as possible, consistent with revenue needs.63 This is probably best achieved with a broad tax base, and a mix of direct / indirect taxes.Error: Reference source not found Production should be taxed as little as possible, since it is generally more economically efficient to tax consumption.Error: Reference source not found, Error: Reference source not found

  3. The tax code should be neutral to the choice of legal form that should be adopted for commercial reasons.Error: Reference source not found Similarly the choice between employment and self-employment should be made for business or personal rather than tax reasons, taking account of employment law and other regulations impacting employers, i.e. the tax and regulatory system should not encourage “quasi-employment”.Error: Reference source not found

  4. The retention of business profits should be encouraged, since this is the most “efficient” source of small business finance, avoiding information asymmetries and the costs of investigation and monitoring associated with “external” sources of finance.Error: Reference source not found

  5. The tax authorities should be supportive of tax payers who want to pay the minimum correct amount of tax on time. Tax administration within government should be efficient; fiscal rules should be as simple as practicable and offer clarity and certainty. Business people, the vast majority of whom are voluntarily compliantError: Reference source not found, should be treated with respect.Error: Reference source not found

  6. The tax code should be designed to minimise tax planning activity. The requirement on business to conduct administration on behalf of government or other taxpayers should be minimised, tax compliance costs should be as low as possible.64 There should be a single point of contact and payment of taxes for businesses, and the amount of time taken up in interaction with the authorities should be reduced as much as possible.Error: Reference source not found

  7. The tax system should be designed to minimise evasion, by offering strong incentives to declare income, including making transactions as visible as possible and where appropriate taxing incomes at source.Error: Reference source not found Economic activity should not be driven “underground” by seeking to tax the “untaxable” i.e. revenues that are not visible and not checkable.Error: Reference source not found Voluntary compliance should be maximised by making business people aware of the risk of audit.Error: Reference source not found


The principles enunciated above are drawn from the literature on taxation and fiscal policy towards small firms. Whilst the theories need to be “translated” into the context of national tax codes, in order to be directly relevant to policy, it is argued that reviewing emerging policies as well as existing tax codes in the light of the extensive theory relating to taxation might lead to enhancements in public welfare or, at least a more holistic view of the role of taxation in public policy towards small firms.



Francis Chittenden is ACCA Professor of Small Business Finance at Manchester Business School; Brian Sloan is a Doctoral Researcher at Manchester Business School.

1 D. Chen, F.C. Lee and J. Mintz, “Taxation, SMEs and Entrepreneurship” (2002) Working Paper Series, OECD Directorate for Science, Technology and Industry.

2 D. Holtz-Eakin, “Public Policy Towards Entrepreneurship” (2000) 15 Small Business Economics at 283.

3 E. Engen and J. Skinner, “Taxation and Economic Growth” (1996) 49 National Tax Journal at 617.

4 See for example B. Erard and J.S. Feinstein, “Honesty and Evasion in the Tax Compliance Game” (1994) 25 RAND Journal of Economics at 1; J. Andreoni, B. Erard and J. Feinstein, “Tax Compliance” (1998) 36 Journal of Economic Literature at 818; R.E. Brown and M.J. Mazur, “IRS’s Comprehensive Approach to Compliance Risk Management” (2003) 56 National Tax Journal at 689.

5 K. Murphy, “Moving Towards a More Effective Model of Regulatory Enforcement in the Australian Tax Office” [2004] BTR at 603.

6 See OECD, ‘Tax Database’, (2004) website resource, available at http://www.oecd.org/document/60/0,2340,en_2649_201185_1942460_1_1_1_1,00.html, accessed 20th April 2007.

7 The Laffer Curve is concerned with the effect of marginal rates on incentives to work, i.e. lower tax rates may stimulate people to work harder and earn more income, so tax revenues rise.

8 See for example E. Engen and J. Skinner, see fn.Error: Reference source not found and J.H. Branson and C.A. Knox-Lovell, “A Growth Maximising Tax Structure for NZ” (2001) 8 International Tax and Public Finance at 129.

9 R. Griffith, S. Redding and J. van Reenen, “Measuring the Cost-Effectiveness of an R&D Tax Credit for the UK”, (2001) 22 Fiscal Studies at 375.

10 J.E. Meade, The Structure and Reform of Direct Taxation (George Allen & Unwin, 1978).

11 For details of the flat tax see R.E. Hall and A. Rabushka, Low Tax, Simple Tax, Flat Tax (McGraw Hill, New York, 1983) and The Flat Tax (Hoover Institution Press, Stanford, 1995). For the Ralph Committee proposals see J. Pope and P. Fernandez, “Current Tax Reform in Australia: An Ambitious Programme” [2001] BTR at 135.

12 M. Calgari, “Flat Taxes and Effective Tax Planning” (1998) 51 National Tax Journal at 689.

13 See J. Pope and P. Fernandez, see fn.Error: Reference source not found.

14 S.R. Bond, M.P. Devereux and M.J. Gammie, “Tax Reform to Promote Investment” (1996) 12 Oxford Review of Economic Policy at 109.

15 See discussions by M.P. Devereux and H. Freeman, “A General Neutral Profits Tax” (1991) 12 Fiscal Studies at 1 and S.R. Bond, M.P. Devereux and M.J. Gammie, see fn.Error: Reference source not found.

16 M. Keen and J. King, “The Croatian Profit Tax: An ACE in Practice” (2002) 23 Fiscal Studies at 401.

17 At 192, J.E. Bolton, Small Firms: Report of the Committee of Inquiry on Small Firm Cmnd.4811 (1971).

18 See for example S.C. Myers, “The Capital Structure Puzzle” (1984) 39 Journal of Finance at 575 and N. Michaelas, F. Chittenden and P. Poutziouris, “Evidence on the Tax and Investment Affairs of Small Firms” (1999) 6 Journal of Small Business and Enterprise Development at 7.

19 T.C. Omer and M.K. Shelley, “Competitive, Political, and Economic Factors Influencing State Tax Policy Changes” (2004) 26 The Journal of the American Taxation Association at 103.

20 B. Walsh, “The Role of Tax Policy in Ireland’s Economic Renaissance” (2000) 48 Canadian Tax Journal at 658.

21 See OECD “Harmful Tax Competition – An Emerging Global Issue” (1998) available at http://www.oecd.org/dataoecd/33/0/1904176.pdf, accessed 20th April, 2007.

22 R. Citron, “The Future of Tax in the 21st Century: A Practitioner’s Perspective” [2002] BTR at 161.

23 S. Fazzari, R.G. Hubbard and B. Petersen, “Investment, Financing Decisions, and Tax Policy” (1988) 78 American Economic Review at 200.

24 Such taxes impact on investment in human and physical capital as well as the allocation of labour and capital. They are therefore considered to be economically inefficient. See for example discussions in E. Engen and J. Skinner (see fn.Error: Reference source not found) and J.H. Branson and C.A. Knox-Lovell (see fn.Error: Reference source not found).

25 See Pre-Budget statement 2005 available at www.hm-treasury.gov.uk, accessed 20th April 2007.

26 J.H. Branson and C.A. Knox-Lovell, see fn.Error: Reference source not found.

27 D. Holtz-Eakin, D. Joulfaian and H.S. Rosen, “Entrepreneurial Decisions and Liquidity Constraints” (1994) 25 RAND Journal of Economics at 334; R.C. Kloosterman, “Creating Opportunities. Policies Aimed at Increasing Openings for Immigrant Entrepreneurs in Holland” (2003) 15 Entrepreneurship and Regional Development at 167; B. Sloan and F. Chittenden, “Fiscal Policy and Self-Employment: Targeting Business Growth” (2006) 24 Environment and Planning C: Government and Policy at 83.

28 D.S. Evans and B. Jovanovic, “An Estimated Model of Entrepreneurial Choice Under Liquidity Constraints” (1989) 97 Journal of Political Economy at 808.

29 J.A. Schumpeter, “The Theory of Economic Development”, 1967 Reprint, Oxford University Press, New York.

30 W.M. Gentry and R.G. Hubbard, “Tax policy and Entrepreneurial Entry” (2000) 90 American Economic Review at 283.

31 B.H. Hamilton, “Does Entrepreneurship Pay? An Empirical Analysis of the Returns of Self-Employment” (2000) 108 Journal of Political Economy at 604.

32 M. Taylor, “Earnings, Independence or Unemployment: Why Become Self-Employed?” (1996) 58 Oxford Bulletin of Economics and Statistics at 253.

33 Examples of literature that argue liquid constrains do not exist include J.E. Stiglitz and A. Weiss, “Credit Rationing in Markets with Imperfect Information” (1981) 71 American Economic Review at 393; D. DeMeza and D. Webb, “Too Much Investment: A Problem of Asymmetric Information” (1987) 102 Quarterly Journal of Economics at 281; R. Cressy, “Are Business Start-Ups Debt-Rationed?” (1996) 106 Economic Journal at 1253. Those that suggest liquidity constrains do exist include D.S. Evans and B. Jovanovic, see fn.Error: Reference source not found; D. Holtz-Eakin, D. Joulfaian and H.S. Rosen, see fn.Error: Reference source not found; A.E. Burke, F.R. FitzRoy, and M.A. Nolan, “When Less is More: Distinguishing Between Entrepreneurial Choice and Performance” (2000) 62 Oxford Bulletin of Economics and Statistics at 565; S.C. Parker, “Asymmetric Information, Occupational Choice and Government Policy” (2003) 113 Economic Journal at 861.

34 C. Keuschnigg, “Taxation of a Venture Capitalists with a Portfolio of Firms” (2004) 56 Oxford Economic Papers at 285.

35 Theoretical evidence can be found in J.E. Meade, see fn.Error: Reference source not found and S. Fazzari, R.G. Hubbard and B. Petersen, see fn.Error: Reference source not found; empirical evidence is provided in J.E. Bolton, see fn.Error: Reference source not found and N. Michaelas, F. Chittenden and P. Poutziouris, see fn. Error: Reference source not found.

36 P. Poutziouris, F. Chittenden and N. Michaelas, “Evidence on the Tax and Investment Affairs of Small Firms” (1999) 6 Small Business and Enterprise Development at 7.

37 A. Redston, “Small Business in the Eye of the Storm” [2004] BTR at 566.

38 At 112, Pre-Budget Statement 2005, see fn.Error: Reference source not found.

39 IR35 is the name given to intermediaries legislation introduced on April 6, 2000. It is named IR35 after the Budget press release that announced its introduction. The aim of the legislation is to eliminate the avoidance of tax and NICs through the use of intermediaries, such as service companies or partnerships.

40 B. Sloan and F. Chittenden, see fnError: Reference source not found.

41 Push factors are described by N. Meager, “From Unemployment to Self-Employment in the European Community” Chapter 3 in F.C. Chittenden, M. Robertson, M. and D. Watkins, “Small Firms: Recession and Recovery” (Paul Chapman 1993); pull factors associated with independence are discussed in B.H. Hamilton, see fn.Error: Reference source not found; financial security factors are described in M. Taylor, see fn.Error: Reference source not found.

42 J. Andreoni, B. Erard and J. Feinstein, see fn.Error: Reference source not found.

43 J.C. Young, “Factors Associated with Non-Compliance: Evidence from the Michigan Tax Amnesty Program” (1994) 16 The Journal of the American Taxation Association at 82.

44 P. Brand, “Compliance a 21st Century Approach” (1996) 49 National Tax Journal at 413.

45 G.D. Myles and Naylor, “A model of tax evasion with group conformity and social customs” (1996) 12 European Journal of Political Economy at 49.

46 B. Erard and J.S. Feinstein, see fn.Error: Reference source not found.

47 See discussions in C. Sandford, M. Godwin, P. Hardwick and I. Butterworth, “Costs and Benefits of VAT” (Heinemann Educational Books 1981); M. Godwin, “The VAT Registration Threshold’ [1998] BTR at 541; K. Murphy, see fn.Error: Reference source not found.

48 J. Andreoni, B. Erard and J. Feinstein, see fn.Error: Reference source not found.

49 A. Hansford, J. Hasseldine and C. Howorth “Factors Affecting the Costs of U.K. VAT Compliance for Small and Medium Sized Enterprises” (2003) 21 Environment and Planning C: Government and Policy at 479.

50 See the work of S. Johnson “Small Firms Policies: An Agenda for the 1990s” at 12 in M. Robertson, E. Chell and C. Mason, “Towards the 21st Century: the Challenge for Small Business” (Nadamal Books, Maccelsfield 1990) and D. Holtz-Eakin, see fn.Error: Reference source not found

51 See fn.Error: Reference source not found and F. Chittenden, P. Poutziouris, N. Michaelas and T. Watts, “Taxation and Small Firms: Creating Incentives for the Reinvestment of Profits” (1999) 17 Environment and Planning C: Government and Policy at 271.

52 For details refer to S. Johnson, see fn.Error: Reference source not found.

53 F. Chittenden, S. Kauser and P. Poutziouris, “Tax Regulation and Small Business in the USA, UK, Australia & New Zealand” (2003) 21 International Small Business Journal at 93.

54 T. Ambler, F. Chittenden and C. Hwang, “Regulation: another form of taxation? UK Regulatory Impact Assessments in 2003/4” (British Chambers of Commerce London 2005); P. Minford, V. Mahambare and E. Nowell, “Should Britain Leave the EU?” (Institute for Economic Affairs London 2005).

55 See the Institute for Fiscal Studies Green Budget 2005, available at www.ifs.org.uk, accessed 20th April, 2007. Specifically at 145.

56 P.J. Wilkie, “Discussion of Organizational Form and Taxes: An Empirical Analysis of Small Businesses” (1996) 18 The Journal of the American Taxation Association: Taxes and Business Strategy at 68.

57 D. Chen, F.C. Lee and J. Mintz, see fn.Error: Reference source not found; B. Sloan and F. Chittenden, see fn.Error: Reference source not found.

58 J.E. Stiglitz and A. Weiss, “Credit Rationing in Markets with Imperfect Information” (1981) 71 American Economic Review at 393.

59 D. DeMeza and D. Webb, “Too Much Investment: A Problem of Asymmetric Information” (1987) 102 Quarterly Journal of Economics at 281.

60 T. Astebro, “The Return to Independent Invention: Evidence of Unrealistic Optimism, Risk Seeking or Skewness-Loving?” (2003) 113 Economic Journal at 26.

61 R. Watson, “Employment Change, Profits and Directors’ Remuneration in Small and Closely-Held UK Companies” (1990) 37 Scottish Journal of Political Economy at 259.

62 J. Andreoni, B. Erard and J. Feinstein, see fn.Error: Reference source not found.

63 J.H. Branson and C.A. Knox-Lovell, see fn.Error: Reference source not found.

64 C. Sandford, M. Godwin, P. Hardwick and I. Butterworth, see fn.Error: Reference source not found; M. Godwin, see fn.Error: Reference source not found.


ADVISORY SUBJECT TAXATION OF CHARITABLE AND HUMANITARIAN ASSISTANCE IN
APPLICATION FOR ABA SECTION OF TAXATION CHRISTINE A BRUNSWICK
ÇAYCUMA VOCATIONAL SCHOOL DEPARTMENT OF ACCOUNTING AND TAXATION ACCOUNTING


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