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This Is Why Entrepreneurial Earnings Are on the Rise!

Despite the arguments of some observers that American entrepreneurship is in decline, the data show that only some types of entrepreneurship are lower than they were in the late 1970s. There is no doubt that new businesses with employees are being created at half the rate they were a generation or so ago, that unincorporated self-employment is down, and that people who lose their jobs and are receiving outplacement services (at least the services of Challenger, Gray, and Christmas) are not as interested in starting businesses as their 1980s counterparts were.

But other types of entrepreneurial activity are on the rise. America has many more non-employers per capita than it did several decades ago. Incorporated self-employment rates have increased. A greater fraction of taxpayers show business income or loss on their individual tax returns, and we have far more companies of all types—sole proprietorships, partnerships, and corporations—per person than we did thirty-plus years ago.

Moreover, even the data on employer businesses are equivocal. Entrepreneurs are founding businesses with paid workers at a slower rate than they once were, but older employer businesses are shutting down more slowly, leaving the stock of employers per capita slightly higher now than in the late 1970s. Because incorporated and unincorporated self-employment has moved in opposite directions, the overall self-employment rate is similar to what it was before the advent of the personal computer, but today a greater fraction of the self-employed are incorporated.

These trends tell a complex story of what has happened to entrepreneurship in America. Most of the stories told by pundits and policymakers—about lack of access to capital, demographic shifts, stifling regulation, and high taxes—are too simplistic to explain accurately what has happened to entrepreneurship since the late 1970s. But before I attempt my own explanation, I need to highlight two other trends that many have missed: what has happened to earnings from business ownership, and what has happened to high-potential ventures.

In this article, I focus on the first of these, profits from running one’s own business. The data on earnings from business ownership indicate that American entrepreneurs are doing just fine—better, in fact, than people who do not run their own companies. Entrepreneurial activity has become more, not less, profitable over time. And, as running a business has become more profitable, the incomes and net worth of business owners have grown faster than those of people who work for others.

American Entrepreneurs Are Making More Money Than a Generation Ago
The hypothesis that American entrepreneurs are making less money than they once did is straightforward and easily testable. Their average income is either the same, higher, or lower than it was three-plus decades ago. We can figure this out by looking at how much money the average American small business has made every year in real—that is, inflation-adjusted—terms. Data on this are available from 1980.

Almost all American small businesses are organized as pass-through entities. Unlike C corporations, which pay their own income tax, the income from a pass-through entity is transferred directly onto the owner’s individual tax return. These companies represent all but the very largest small businesses—the handful organized as C corporations. The annual income of pass-through entities thus tells us how much money American entrepreneurs are making each year (or at least provides a decent approximation).

The data on these earnings come from our nation’s tax authority, which imposes steep penalties for lying on one’s return, making the numbers very reliable. If we look at the IRS data on the average American pass-through business’s income over time, we can get a pretty good sense of whether entrepreneurship is getting more profitable, or less.

The average business run by an American entrepreneur is generating more income, adjusted for inflation than it did three decades ago. With the exception of the years of the Great Recession, which adversely affected entrepreneurial earnings, as it did all other earnings, the average income of pass-through entities has seen a steady rise. Between 1980 and 2012, earnings of the average American pass-through entity rose 196 percent after accounting for inflation. That’s far from a marginal increase. American entrepreneurs are making a whole lot more money than they did a generation ago.

It is not true just for the entrepreneur who chose to organize his or her business as a corporation, or partnership, or sole proprietorship. If we look at specific types of businesses, we see the same patterns. The real average net income of Subchapter S corporations has risen considerably over the past three-plus decades, from $12,239 (again, in 2010 dollars) in 1980 to $107,527 in 2012. That’s a nearly ninefold increase, and it comes despite the battering these incomes suffered in the Great Recession.

Real Average Net Income of Pass-Through Entities
Source
: Created from data from the Internal Revenue Service.
Real Average Net Income of S Corporations
Source: Created from data from the Internal Revenue Service.

Because the IRS is not terribly concerned about how quickly it produces its statistical data, some of its numbers are more current than others. Its information on sole proprietors is more up to date than figures on other legal forms of business. That’s a good thing. Because sole proprietors comprise roughly three-quarters of all U.S. small businesses, statistics about them tell us the most about how American small business owners are performing.

The data on sole proprietorships’ profit margins show that sole proprietors are taking home a larger share of their revenues as profits every year. Once again, that’s inconsistent with the story that American entrepreneurs are earning less than they used to. If American entrepreneurs are struggling, their average net income as a fraction of revenue should be going down—they should not be taking a greater portion of their revenues as profits.

As you might expect, the Great Recession was not kind to sole proprietors. But overall, sole proprietors’ margins have been trending upward since the late 1980s. From 1988 to 2013, net income as a percentage of revenue rose from 18.8 percent to 22.5 percent.

And margins have risen not just for sole proprietors. For Subchapter S corporations, net income as a percentage of revenue has also increased substantially. In 1980, profit margins were 1.2 percent. In 2012, they had reached 7.2 percent, a sixfold increase. Partnerships tell the same story. Since 1980, their net income as a percentage of revenue went from 3 percent to 16.6 percent, a five-and-a-half-fold rise.1

In short, American entrepreneurs are making more money than they were a generation ago. The income for all types of pass-through entities is up substantially in inflation-adjusted terms. Sole proprietors and Subchapter S corporations have seen their margins increase. These changes suggest rising, rather than declining, entrepreneurship.

Proprietors’ Net Income as a Percentage of Revenue
Source: Created from data from the Internal Revenue Service.