CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Taxation, apart from being the major source to finance government’s responsibilities, it is also a means of ensuring that certain economic policies of government such as creation of friendly environment for private business/enterprises are brought into fruition. As economic regulator, taxation is a potent tool for promotion of economic welfare through creation of tax friendly economy conducive for businesses to survive and grow (Osita, 2011).

The creation of new companies by entrepreneurs who seek to profit from exploiting business opportunities is a fundamental force for economic growth. This process, first identified by Schumpeter (1911, 1942) and formalized by Aghion and Howitt (1992), has been documented since Hause and du Rietz (1984). Economic policies aimed at fostering the entry of new companies are high on many governments’ agenda for their potential benefits for innovation, competition, employment, and growth (Aghion and Howitt, 2006). Several recent studies have looked at this issue from a variety of angles, exploiting the increasing availability of firm-level data to assess the impact of different economic policies on entry and economic activity. This literature focuses on the effects of labor, credit, and product market regulations on entry and on the characteristics of entrants and incumbents.

The corporate income tax generates a distortion by taxing corporate income at a different rate than if the same income were earned in non-corporate form. Typically, corporations pay tax on income earned at the corporate level and then shareholders pay either capital gains or dividend taxes when it is distributed to them. The fact that the taxation of corporate income generally exceeds that of personal income raises the question of how distortionary the corporate income tax is in practice.

The issue is central to standard work on the subject such as Harberger (1966), Shoven (1976) or Ballard et al. (1985). These models have viewed some industries as being corporate (e.g., manufacturing) and others non-corporate. When simulated in computable general equilibrium models, the results tend to suggest relatively small efficiency costs from corporate taxation because activity does not easily shift between sectors. A more recent literature, Gravelle and Kotlikoff (1988, 1989, 1993), in particular, argues that, because there can be both corporate and non-corporate production in the same industry, corporate income taxation can lead to large amounts of shifting between organizational forms and that in such a model, the deadweight loss (DWL) from the corporate income tax is extremely large. The key determinant of the DWL in these models is how much firms in the same industry shift to non-corporate forms in response to the corporate income tax and this is an empirically testable idea.

The extent to which a corporate tax increase induces firms to shift out of corporate form then becomes an important way to think about the distortion created by the corporate income tax. This is the subject of Gordon and Mackie-Mason (1990, 1994, 1997) and Goolsbee (1998) specifically but is also implicit in the large literature on how corporate taxes affect organizational form decisions. 

Entrepreneurship is generally viewed as an important determinant of innovation and growth. For this reason, public policy has focused on entrepreneurial activity and on the organizational form in which it often takes place: self-employment. One of the main components of entrepreneurial public policy in all developed countries is the taxation of the self-employed. However, empirical estimates of the effect of taxation on the level of entrepreneurship is generally inconclusive (Bruce and Schuetze 2004). One reason is that entrepreneurship is a somewhat vague concept, hard to de ne exactly and harder still to measure. Kanniainen and Panteghini (2013) argue that the analysis of taxes must take into account the fact that entrepreneurship is complex and involves several simultaneous decision margins. The authors show that even in situations where taxes are neutral with respect to the entrepreneurial investments, taxes may distort the occupational choice: whether to become an entrepreneur in the rest place. Another reason for the lack of consensus regarding the effect of taxes is that the theoretical prediction regarding the relationship between taxation on entrepreneurship is ambiguous.

There are at least four ways in which taxation can affect entrepreneurial entry (Bruce and Gurley 2004). Most simply, the effect of taxes is to lower returns on effort and risk taking; personal taxes on entrepreneurs reduce investments, hiring and rm growth (Carroll et al. 2000a, 2000b, 2001). On the other hand, taxes can stimulate risk taking activities by compressing the distribution of after-tax returns, at least for the marginal investment, when losses are fully deductible (Domar and Musgrave 1944). Taxes can also increase self-employment if entrepreneurs face lower taxes than employees or if self-employment makes it easier to evade taxes (Gordon and MacKie-Mason 1994; Gordon 1998; Bruce 2000; Cullen and Gordon 2007, Stenkula 2012).

When taxes are progressive rather than at, a fourth mechanism has been suggested. Since entrepreneurial returns are more dispersed than wages, the progressivity of the tax schedule matters as well as the level of taxation. In an influential paper Gentry and Hubbard (2000) demonstrate that high marginal tax rates discourage entry into self-employment. The result that these success taxes discourage entrepreneurial entry is consistent with the risk-sharing framework of Domar and Musgrave (1944), since high marginal taxes amplify the asymmetry in a tax system where losses below bankruptcy level are not tax-credited.

Taxation increases incentives for public participation in the political process and creates pressure for more accountability, better governance, and improved efficiency of government spending. Taxation also creates incentives for governments to upgrade their institutions for tax collection and administration and to provide more public services (Moore, 2007). Corporate profits distributed as dividends suffer the so-called double taxation, since they are taxed both at corporate and personal income levels (by the corporate income tax and the dividend tax, respectively). The literature has long emphasized that corporate income taxation diminishes investment by firms by reducing the after-tax return on capital. In this paper, we show that these distortions are much more severe when firms’ growth over the life cycle is constrained by financial frictions.

 The impact of dividend taxation on firm investment decisions critically depends on the stage that firms are in their life cycle, as young firms are more likely to issue equity and old firms are more likely to issue dividends. Young firms behave according to the traditional view’ in the finance literature that focuses on how raising the cost of equity finance (dividend taxation) negatively affects firms investment. However, as emphasized by the new view in the finance literature, dividend taxation does not affect investment decisions of firms distributing dividends (mature firms) since the dividend tax leads to an equi-proportional reduction in the return and costs of investment. More generally, our paper stresses that the various ways capital income can be taxed (whether corporate income, dividend, or capital gains taxation) have quite different effects on investment and payout policies over the life cycle of firms, and hence on the life cycle growth of firms. They also have different and asymmetric effects on the market valuation of new versus incumbent firms and thereby on firm entry (Auerbach, 2002).

Taxation provides a predictable and stable flow of revenue to finance development objectives. This is important in a country like Cameroon that has serious challenges with meeting its development objectives. Small and medium enterprises (SMEs) are significant for economic growth in the country, contributing as much as about 22 percent of the gross domestic product of Cameroon. SMEs generate taxable incomes and they also collect employment and value added taxes on behalf of the government. Taxation, however, imposes high cost to small businesses. SMEs are less tax compliant in comparison to large businesses. SMEs are considered the ‘hard to tax group from the informal sector.’ As such, the literature suggests that only a fraction of their taxable incomes is reported to tax authorities. Against this background, factors that correlate with tax compliance of 575 small and medium size companies in Cameroon are discussed from a survey of companies in the manufacturing and wholesale sectors. High registration cost and time-consuming processes promote tax non-compliance. The perception that tax system is corrupt discourages registration and filing compliance. When there are too many compliance hurdles, the probability of filing compliance is reduced. However, a fair and static system encourages filing and registration compliance. A clear and consistent tax system promotes filing compliance. Authorities that understand their responsibilities and are willing to respond to enquiries during the registration process promote tax compliance in general.

1.2 Statement of the Problem

The startup rate defined as the ratio of zero-year-old firms to the total number of firms has witnessed a declined especially in developing countries recetly . The decline in startup activity is a source of growing concern. It has been linked to a decline in the dynamism and vitality of the world economies (Decker et al., 2014). A decline in startups has also been connected to productivity slowdowns (Clementi and Palazzo, 2016), jobless recoveries (Pugsley and Sahin, 2019), and overall persistent effects on the macroeconomy (Gourio et al., 2016). Nevertheless, the reasons behind the decline in the startup rate are not well understood.

Most business owners are aware of taxes paid, uncertain of the mode of assessment and little assistance is given as regards tax awareness (Tasha et al., 2023). Taxation was highlighted as a key impediment to the performance of SMEs pf which startups are part and high tax rates are a major feature that influenced the performance of SMEs in Cameroon. Despite efforts by the government of Cameroon to enhance the growth and performance of SMEs, taxation still remains a major obstacle to the growth of SMEs in Cameron since it has continuously affect their performance and sustainability (Turyatemba et al., 2022). The deficiencies in the performance of SMEs associated with the ineffective tax policies in Cameroon may affect the ability of these enterprises to mobilize the required financial and nonfinancial resources

Although there is a general perception that corporate tax is an important source of funds for the development of an economy and the provision of social services, the problems faced are in the area of negative relationship between taxes and the business’ ability to sustain itself and to expand. Start-ups are faced with the problem of high corporate tax rates which affects the size and strength of the small business population in several ways. They can reduce the number of business births by discouraging those who might otherwise form new businesses. They can slow down the rate at which small businesses are able to grow by making it more difficult for them to finance a rapid expansion. It is for the above elaborations that this study sets out to investigate the effects of corporate on the growth and survival of startup businesses in the North West Region of Cameroon.

1.3 Research Questions

This study is guided by the following research questions;

• What is the effect of corporate tax rate on the growth and survival of startups and small corporations?
• What is the effect certainty of corporate tax on the growth and survival of startups and small corporations?
• To what extent does complexity of payment of corporate tax on the growth and survival of startups and small corporations?

1.4 Research Objectives

1.4.1 Main Objective

The main objective of this study is to examine the effect of corporate tax on the growth and survival of startups and small corporations in the North West Region.

1.4.2 Specific Objectives

• To examine the effect of corporate tax rate on the growth and survival of startups and small corporations.
• To investigate the effect of certainty of corporate tax on the growth and survival of startups and small corporations.
• To examine the extent to which complexity of payment of corporate tax on the growth and survival of startups and small corporations.