Prior research investigates the role of start-up costs and taxes with regard to entrepreneurship. Yet, little distinction is made regarding the type of entrepreneurship, particularly innovative versus non-innovative entrepreneurship. We shall argue that start-up costs and taxes are associated in different ways with innovative versus non-innovative entrepreneurship. Taxes being recurring costs should mainly relate to innovative entrepreneurship, whereas start-up costs being one-off costs should mainly relate to non-innovative entrepreneurship. Analyzing a dataset of 632,116 individuals, including 43,223 entrepreneurs from 53 countries, we can partially confirm our predictions. Corporate taxes show a negative relationship with innovative entrepreneurship, whereas income taxes seem to have no relationship. High start-up costs have a positive relationship with innovative entrepreneurship, although this finding only holds true in cross-sectional investigations. Our paper contributes to the discussion on how governmental regulation and taxes relate to entrepreneurship.

Introduction

A large prior literature has investigated how government regulations, policies, and actions relate to entrepreneurship (see Blackburn and Schaper (2016), for a summary). Within this literature, many studies have investigated the role of taxes and start-up costs (Gentry and Hubbard 2000; Djankov et al. 2002; Klapper et al. 2006; Cullen and Gordon 2007; Braunerhjelm and Eklund 2014; Block 2016). Both taxes and start-up costs can be directly influenced by government policy and are shown to have strong relationships with entrepreneurship rates. So far, no study has investigated the role of taxes and start-up costs with regard to innovative entrepreneurship. This is an important oversight, as we believe that the distinction between innovative and non-innovative entrepreneurship is an important one. While many policy-makers and scholars use the terms innovation and entrepreneurship interchangeably (Dreher and Gassebner 2013; Autio et al. 2014) and even try to stimulate one in the hope of getting more of the other, only very few entrepreneurs innovate (Reynolds et al. 2005; Block et al. 2017). Yet, prior research shows that, in particular, such innovative entrepreneurs are responsible for economic growth and development (Autio et al. 2014; Block et al. 2017). We shall argue that start-up costs and taxes are associated in different ways with innovative entrepreneurship. Start-up costs such as notary charges or registration costs are one-off costs that increase the barriers of entry into entrepreneurship. High start-up costs are usually associated with low entrepreneurship rates. Yet, high start-up costs may not only influence the quantity of entrepreneurship but also the quality and type of entrepreneurship. In fact, high start-up costs may lead to a positive selection of those individuals who are highly motivated and expect high incomes from entrepreneurship. Monteiro and Assunção (2012), Branstetter et al. (2014), and RostamAfschar (2014) find that low start-up regulations attract low quality entrepreneurs with low expected returns. We argue that innovative entrepreneurs expecting high returns (Schumpeter 1934) are more willing, compared to other entrepreneurs, to incur high start-up costs. In addition, they are usually well positioned to attract external funding (Desai et al. 2003). Taxes, in turn, represent recurring costs reducing the gains from innovation and entrepreneurial profit. They have a deterrent and discouraging effect particularly for risk-taking entrepreneurs with innovative ideas (Hansson 2012). Taxes reduce the expected return on innovation and, thus, discourage innovative entrepreneurship.