Income Shifting and the Cost of Incorporation

Abstract

Drawing on administrative data covering the full population of self-employed individuals in the UK, I study the extent of income shifting from personal to corporate tax bases through incorporation. Despite large tax savings to incorporation (exceeding 10% in some years), a substantial proportion of business owners fails to incorporate. Using a revealed preference approach, I estimate an average cost of incorporation to be greater than £1860. Next, I estimate a proportional hazard model and uncover moderate elasticities of hazard rate of incorporation with respect to tax savings. These findings imply that income shifting through incorporation is important but not the primary avoidance channel for the self-employed. At the same time, the large perceived cost of incorporation implies that barriers to entrepreneurship remain large.