The purpose of this research is to add to the policy debate by investigating whether closing the health insurance tax incentive gap between employees and the self-employed enhances entrepreneurial survival. Wage and salary employees are able to purchase health insurance for themselves and their families with pre-tax dollars, thereby lowering their out-ofpocket expense for health insurance.

Health insurance premiums paid by the self-employed have historically received different tax treatment. The selfemployed were not able to deduct health insurance premiums when calculating income tax or payroll tax liabilities prior to 1987.

A self-employed health insurance deduction for income tax purposes was implemented in 1987 and made permanent ten years later. However, this did not equalize the tax treatment of health insurance premiums as self-employed health insurance premiums are still not deductible in payroll tax calculations.

This paper explores how the tax treatment of self-employed health insurance premiums affects entrepreneurial decisions. The study examines tax return data for self-employed entrepreneurs over a three-year period when the tax deductibility of health insurance premiums was being phased in. This data is used to estimate the effect that the deduction had on the probability that an entrepreneurial filer who claimed it would continue in entrepreneurial activities in the following filing year.

Overall Findings
The income tax deductibility of health insurance premiums for self-employed filers has a positive effect on the rate of entrepreneurial survival. The study finds that the rate of exit from entrepreneurial activity decreases when filers are permitted to deduct a portion of health insurance premiums on federal income tax filings.

The effect holds for both single filers (who are generally younger, earlier in their career, and less risk averse), as well as for married filers (who are often older and have dependent family members). The effect of the deduction on married filers is greatest. Married filers who took the deduction are more likely to remain in an entrepreneurial activity. As the value of the deduction grows, single filers' exit rates decline more than those of married filers.

The findings generally confirm the observation that lower tax rates on entrepreneurial income tend to increase entrepreneurial activity; larger deductions of health care expenditures reduce the tax bills of those who purchase insurance. The observed decreases in the probability of entrepreneurial exit are an important consideration when evaluating policies to allow a health insurance deduction in calculating payroll tax liabilities.

Highlights
The author's results offer compelling evidence that health insurance deductibility enhances entrepreneurial survival.

• The presence of a health insurance deduction decreases the probability that a self-employed entrepreneur will choose to exit the entrepreneurial sector by 2.65 percentage points for single filers. The average probability of exit for single filers over the sample period was 24.49 percent, thus the marginal effect of the health insurance deduction was a 10.82 percent reduction in the likelihood of exit.

• For married filers, the presence of a health insurance deduction decreases the rate of exit from entrepreneurship by 10.52 percentage points. Given that the average rate of exit for married filers over the sample was only 16.19 percent, this represents a dramatic reduction in entrepreneurial exit of almost 65 percent.

• Similarly, changes in the dollar value of the health insurance premium deduction also have large effects on the probability of exit from entrepreneurship. For single filers the relationship is almost unit elastic, a 10 percent increase in the value of the deduction reduces the probability of exit by 10.62 percent. However, for married filers the relationship is rather inelastic: a 10 percent increase in the value of the health insurance deduction causes only a 1.23 percent reduction in exit probability.

Download Health Insurance Deductibility and Entrepreneurial Survival

PDF format, 375KB, 31Pages.

Tami Gurley-Calvez, Alexandria, VA 22314
2006. [29] pages. Under contract SBAHQ-04-M-0536

INTRODUCTION
Health insurance premiums paid by employers on behalf of employees have historically received different tax treatment than premiums paid by the self-employed for themselves and their dependents. Health insurance premiums paid by employers are generally deductible in calculating both income and payroll taxes for wage and salary workers.2 Additionally, other tax provisions such as flexible spending accounts allow employees to pay their share of premiums and medical expenses out of pre-tax dollars. ...

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