During the economic boom of the 2000s, poverty rates declined in many states. Yet some states were more effective at getting the poverty rate down than others. While there has been much analysis of why some states are more successful than others, what’s been missing is a discussion of the role of entrepreneurs in the process. This paper suggests that economic freedom and entrepreneurship are keys to escaping poverty for many.
There is a strong connection between a state’s rate of entrepreneurship and declines in poverty. Statistical analysis of all 50 states indicates that states with a larger share of entrepreneurs had bigger declines in poverty. In fact, comparing states during the last economic boom—from 2001 to 2007—data show that for every 1 percentage point increase in the rate of entrepreneurship in a state, there is a 2 percent decline in the poverty rate.
To help reduce poverty, policymakers should focus on increasing the number of entrepreneurs in their state. Research shows that one of the most effective ways to increase entrepreneurship is by lowering tax burdens. In particular, this study shows that high tax burdens, measured as a percentage of personal income, drags down the growth rate of entrepreneurship in a state: for every 1 percentage point increase in the tax burden, there’s a corresponding 1 percentage point drop in the entrepreneurship rate. States without income taxes also have higher average rates of entrepreneurship than those with income taxes. The average number of sole proprietors as a percentage of employment in states without an income tax is 21.7. The rate for states with an income tax is 19.6.
Pulling out all the stops to increase the rate of entrepreneurship should be a top priority for policymakers. In a small state like Arizona the results can be dramatic. Increasing the rate of entrepreneurship from 16 to 20 percent would mean 100,000 more entrepreneurs are starting a business.