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Sweat Equity in U.S. Private Business

Staff Report 560 | Published December 30, 2019

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Sweat Equity in U.S. Private Business

Abstract

We develop a theory of _sweat equity_—which is 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 tax rates on business incomes—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 results in increased self-employment and smaller firm sizes, whereas lower rates on employees has the opposite effects. Allowing for financial constraints and superstar firms does not overturn our main findings.