Working Paper: NBER ID: w24520
Authors: Anmol Bhandari; Ellen R. McGrattan
Abstract: We develop a theory of sweat equity—the value of business owners’ time and expenses to build customer bases, client lists, and other intangible assets. We discipline the theory using data from U.S. national accounts, business censuses, and brokered sales to estimate a value for sweat equity for the private business sector equal to 1.2 times U.S. GDP, which is roughly the value of fixed assets in use in these businesses. Although latent, the equity values are positively correlated with business incomes, ages, and standard measures of markups based on accounting data, but not with financial assets of owners or standard measures of business total factor productivity (TFP). We use our theory to show that abstracting from sweat activity leads to a significant understatement of the impacts of lowering business income tax rates on both the extensive and intensive margins. We also document large differences in the effective tax rates and the effects of tax changes for owner and employee labor inputs. Lower tax rates on owners result in increased self-employment rates and smaller firm sizes, whereas lower rates on employees have the opposite effect. Allowing for financial constraints and superstar firms does not overturn our main findings.
Keywords: sweat equity; private business; tax policy; intangible assets
JEL Codes: E13; E22; H25
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| sweat equity (M52) | overall business income (L21) |
| business age (M13) | overall business income (L21) |
| lowering tax rates on owner income (H31) | increased self-employment rates (J23) |
| lowering tax rates on owner income (H31) | smaller firm sizes (L25) |
| lowering tax rates on employees (H32) | larger firm sizes (L25) |
| neglecting sweat equity (M52) | underestimating impacts of tax reforms on business behavior (H32) |
| sweat capital (P12) | standard measures of TFP (D24) |