Firm Entry Dynamics and Taxation of Corporate Profits: Evidence from Europe (Replaced by DP 2009-61)

Can tax policy foster the creation of new companies? To answer this question, we assemble a novel country-industry level panel database with entry data of European companies between 1997 and 2004. We compute effective tax rates and explore the effect of corporate taxation policy on entry rates at country-industry level. Drawing on the recent political economy literature, we also account for the endogeneity of taxation. We find a significant negative effect of corporate income taxation on entry rates. The effect is concave and suggests that tax reductions affect entry rates only below a certain threshold tax level. We also find that a reduction in corporate tax rates is more effective in countries with better institutional infrastructure. Our results are robust to alternative measures of effective taxation and to the use of alternative and additional explanatory variables.