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We investigate the role of health insurance coverage in explaining transitions in and out of entrepreneurship in the U.S. We first consider the effect of individual coverage, along with that from a spouse, on the likelihood of entry and exit. Next, we examine the tax deductions granted to the self-employed through amendments made to the 1986 Tax Reform Act. Using the Current Population Surveys for 1996–2007, we find that while the increasingly generous tax deductions left entry decisions largely unaffected, they had limited effects on exits. Thus, the health care system in the U.S. may have implications for entrepreneurial activity.

At the individual level, the decision to enter entrepreneurship involves assuming various forms of uncertainties associated with running a new business venture. Leaving wage/salary employment for entrepreneurship often means risking the security of a steady source of income. The unique health care system in the U.S. poses an additional challenge for those who consider engaging in entrepreneurial activity because departing a wage/salary job often means losing access to good health care coverage as well. The U.S. is the only major industrialized country without universal health care. The cost and availability of health insurance in the U.S. has long been identified as a major concern for smaller businesses. The self-employed and those who work for very small businesses (fewer than 10 employees) make up more than a third of uninsured working non-elderly in the U.S. (Fronstin, 2013). With a few notable exceptions, the established literature has overlooked the possibility that the health care system in the U.S. may have implications for entrepreneurial activity. Instead, the existing studies have primarily focused on whether health insurance factors significantly reduce the labor market mobility of wage/salary workers, i.e. “job-lock.” In this paper, we address the gap in the literature regarding “entrepreneurship lock” and quantify the role of health coverage in explaining entrepreneurial entry and survival in the U.S. While the recent health care reforms attempt to address the disadvantages faced by the existing and potential entrepreneurs, we analyze past policies that offered tax incentives to the self-employed for their health insurance purchases. We follow the existing literature on occupational choice and job-lock to analyze the effects of health insurance factors on: (i) the decision to become self-employed, as opposed to remaining in wage/salary jobs; and (ii) the decision to stay self-employed. In our empirical analysis, we form a large panel of data for 1995–2005 that uses more than 10 years of nationally representative Current Population Surveys. We initially replicate the conventional job-lock analyses by exploring variations in an alternative source of coverage—namely that available through a spouse. Since this empirical strategy can produce biased estimates due to the potential endogeneity of spousal health insurance, we next examine a tax policy that attempted to level the playing field between the self-employed and wage/salary workers in terms of the availability and affordability of health insurance. Specifically, we analyze a series of amendments made to the 1986 Tax Reform Act between 1996 and 2003 that allowed entrepreneurs to deduct a gradually increasing portion (from 25% to 100%) of their health insurance premiums from their taxable income. We show that the increasingly generous tax deductions offered to the self-employed had a limited effect on entrepreneurial survival without much of an impact on the entry decisions. Therefore, offering tax deductions alone, without adopting other policies in the U.S. health care system, may not provide sufficient incentives to increase the attractiveness of entrepreneurship.

In this paper, we examine labor market transitions—both entry from WS employment into SE and exit from SE into WS jobs. Our preferred identification strategy based on the TRA86 amendments suggest that the tax deductions for health insurance purchases may not necessarily encourage WS men to enter SE but might have an impact on some entrepreneurs' decision to remain SE. One possibility, as mentioned above, might be due to the fact that a lot of the SE report no profits in the first few years of business and thus cannot take advantage of the tax deductions. The limited response to the TRA86 amendments could also be due to the difficulties associated with obtaining private non-group health insurance, above and beyond the higher premiums. Even the full deductibility of health insurance premiums may not compensate for high search costs, potential denial, exclusion restrictions on pre-existing conditions, etc. (Blumberg and Nichols, 2004 and Pauly and Nichols, 2002). Hence, simply offering tax deductions may not provide sufficient incentive for individuals to take on the risks inherent in entrepreneurial endeavors. All of this echoes the ongoing conversation over the implementation of a comprehensive health care reform in the U.S. with various provisions under the ACA. For example, the ACA calls for the formation of state-based health insurance exchanges where individuals and small businesses can purchase qualifying coverage. Temporary subsidies are offered to provide relief for individuals who find themselves in the non-group market. However, it is not clear yet as to what extent these reforms will help SE individuals and those working for small firms. The Kauffman-RAND Institute for Public Policy claims that the ACA could lead to a 33% “bump in entrepreneurship” over several years conditional on the performance of state-based exchanges (Maltby and Loten, 2013). As the Act's implementation has already begun, its effects on entrepreneurship should definitely be a fruitful venue for future research. Holtz-Eakin et al. (1996) also report limited to no response of the entrepreneurial transition decisions to health insurance factors. They point out that this may not be particularly surprising as undertaking entrepreneurship involves substantial risks. The lack of coverage may be one of the risks that such individuals are willing to undertake and therefore may not constitute a major impediment to entry decisions. This explanation echoes earlier arguments that entrepreneurs are more likely to be the relatively less risk-averse individuals (e.g., Kihlstrom and Laffont, 1979). Even though Holtz-Eakin et al. (1996) use the Panel Study of Income Dynamics and the Survey of Income and Program Participation, which follows individuals for longer periods than the CPS does, they still focus on year-to-year labor market transitions. They argue that the effects of health insurance will be greater in the short-run than in the long-run. In this respect, the fact that the ORG in the CPS is a short panel does not constitute a particular concern. A longer panel may, to some extent, enable one to address the duration of the SE enterprises, however. For example, the observed exits from SE may occur mostly for the newly formed business ventures, as they tend to be especially volatile in their first few years. This could also affect the TRA86 eligibility for an entrepreneur to be able to claim the tax deduction. Unfortunately, the CPS lacks data on the nature of entrepreneurship and thus the implicit assumption underlying our analysis is that the SE is a homogenous group. As a result, it is difficult for us to judge whether entries and exits are desirable or not. While we treat all entries and exits equally, previous literature has distinguished between different modes of entry (e.g., Lofstrom et al., 2014 and Parker and van Praag, 2012) as well as different exit routes (e.g., Bates, 2005 and Wennberg et al., 2010). Although we control for industry and occupation in our analyses, we do not have detailed information on the nature of SE. Despite these shortcomings, the CPS does include details regarding a respondent's health insurance policyholder status, along with an opportunity to observe the labor market transitions for a large sample of WS, and especially SE individuals. Although only a minority of SE hire employees (13.6% in 2009 according to Hipple (2010)), future research could investigate whether health insurance factors could limit their job creation and business growth. Another fruitful area for future research could be the inflow of skilled immigrant entrepreneurs from countries with universal access to health care into the U.S. The relatively more favorable provisions for entrepreneurs in the U.S. tax system are considered as an important structural or institutional factor that can attract successful entrepreneurs from countries such as Canada and Australia (Schuetze and Antecol, 2006). On the other hand, the unique difficulties associated with the health care system in the U.S. can potentially act as a barrier for entrepreneurs coming from abroad. The job-lock literature has attracted considerable attention to the WS jobs but entrepreneurial activity is an important consideration as well. This paper serves as one of the first steps in addressing the importance of health insurance in the U.S. as it relates to entrepreneurship which deserves further exploration in future research.