Intertemporal income shifting and taxing owners of closely held businesses

Owners of closely held businesses often receive favourable tax treatment and are highly responsive to the tax system. We show that the high responsiveness of owners of closely held UK businesses is entirely explained by intertemporal income shifting. Individuals shift income across years to smooth taxable income around tax kinks, but they also shift income over longer periods, allowing them to access favourable capital gains tax treatment at company liquidation. Ignoring income shifting leads to an overestimate of the potential deadweight loss from taxing these individuals. Our results are informative about the avoidance costs associated with tax breaks offered to “entrepreneurs”.

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