Raising the Stakes : How Individual Tax Rates Affect Risk-Taking by Pass-Through Businesses

Pass-through businesses (PTBs) generate over 60 percent of business income; yet little is known about how individual tax rates affect PTBs’ risky investment. This is important because PTBs face a different tax system than corporations, with characteristics predicting divergent relations between tax rates and risk-taking. We study PTBs using the unique setting of thoroughbred racing and how individual taxes affect the decision to enter risky stakes races or less risky allowance races. The setting is advantageous because we can observe the choice between two discrete investments with different levels of risk. Using a difference-in-differences design, we find investment in stakes races increases in the U.S. relative to Canada following the rate reduction in the Tax Cuts and Jobs Act. We also find a negative relation between state tax rates and risk-taking in additional analyses. Our findings suggest owners of PTBs face significant payoff asymmetry, which has real effects on investment