11 February 2014

Taxes and Girlfriends - Two Fairly Minor Reasons Entrepreneurs Choose a Particular City to Start a Business

Interviewing entrepreneurs about why they chose the city they did, tax policy got mentioned only slightly more than girlfriend. (Interesting article by Richard Florida at Atlantic Cities, What Cities Really Need to Attract Entrepreneurs, According to Entrepreneurs.) What mattered in their choice was finding a city they wanted to live in themselves and that had a large enough population that they felt they'd be able to find and attract talent.

Daniel Kahneman explained the psychology of loss and gain through one study of risk aversion. One group was given a coffee mug with an insignia from their old university. The researchers then offered to buy it from them and the average price at which they agreed to give up their new mug was about $7. Another group was offered a coffee mug with an insignia and asked to bid for it; the average price was about $3.5, about half as much. From these sorts of results, Kahneman concluded that people put a higher price on losing what they already have than on gaining what they don't yet have. This aversion to loss has a profound impact on our choices.

In recent decades, policy to encourage entrepreneurship has been about adding to the reward: lower taxes for the rich or for investors. Since Eisenhower, the marginal tax rate on top income people has been halved.

But if Kahneman's studies and Florida's report is any indication, that's pretty expensive and it would seem that most entrepreneurs feel like if they're successful they'll get rich anyway. The more interesting question that cities should ask is, How do we lower risk of failure? People apparently put twice as much value on what they have as what they have yet to get; policies that lower the chance of loss could do far more to induce risk takers to start businesses than tax breaks.

Incubators that distribute the costs of start ups, licensing processes that are affordable and easy to navigate, mentoring programs, and any policies that make the up front costs less onerous would seem to offer more psychological inducement than the promise of lower taxes once entrepreneurs have been successful.

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