Health Insurance Deductibility and Entrepreneurial Survival

Tami Gurley-Calvez, Alexandria, VA 22314

2006. [29] pages. Under contract SBAHQ-04-M-0536 

This report was developed under a contract with the Small Business Administration, Office of Advocacy, and contains information 

and analysis that was reviewed and edited by officials of the Office of Advocacy. However, the final conclusions of the report do not 

necessarily reflect the views of the Office of Advocacy.

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.

April 2006 No. 273
• 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.

Scope and Methodology

This research examines the relationship between 

entrepreneurship and the tax deductible status of 

health insurance premiums using a dataset of individual tax return data to perform an econometric 

analysis on the data. The study defines “entrepreneurship” as the existence in a given data year of 

a Schedule C tax return for a given tax filer. The 

data are drawn from the University of Michigan Tax 

Research Database, constructed from public-use tax 

return data released by the Internal Revenue Service 

Statistics of Income Division. The data contain a 

random sample of all filers over the period 1988 to 

1990. The sample period was chosen because 1988 

was the first year a significant number of Schedule 

C filers claimed the health insurance deduction, and 

1990 is the final year for which data are available. 

Because the data panel includes observations on a 

large number of individuals over a number of years, 

a random effects regression model was employed to 

control for unobservable individual heterogeneity. 

Other variables control for age, household size, presence of and age of children, liquidity constraints, and 

risk attitudes.

This report was peer-reviewed consistent with 

Advocacy’s data quality guidelines. More information on this process can be obtained by contacting the director of economic research by email at 

advocacy@sba.gov or by phone at (202) 205-6533.

Ordering Information

The full text of this report and summaries of other 

studies performed under contract with the U.S. Small 

Business Administration's Office of Advocacy are 

available on the Internet at www.sba.gov/advo/research. 

Copies are available for purchase from:

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Springfield, VA 22161

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www.ntis.gov

Order number: PB2006-106646

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