Working Paper: NBER ID: w2832
Authors: James M. Poterba
Abstract: This paper investigates the links between capital gains taxation and the level of venture capital activity. I examine two explanations of how reducing the personal capital gains tax rate may spur venture capital: the first focuses on the supply of funds to the venture industry, and the second on the supply of entrepreneurs. The supply of funds is unlikely to be the principal mechanism through which the tax affects venture capital, since less than half of venture investors face individual capital gains tax liability on their realized gains. Moreover, most of the growth in venture funding during the last decade has come from tax-exempt investors. Individual capital gains taxes may however have a significant influence on the demand for venture funds. These taxes have an important impact on the incentives of entrepreneurs and other employees of start-up firms who forego wage and salary income and accept compensation through corporate stock and options. The paper closes by noting that reducing the tax rate on all gains is a relatively blunt device for encouraging venture investment. Venture investments account for less than one percent of realized capital gains.
Keywords: venture capital; capital gains taxation; entrepreneurship
JEL Codes: H25; G24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Reducing the personal capital gains tax rate (H24) | Spurring venture capital (G24) |
| Reducing the personal capital gains tax rate (H24) | Influencing the supply of entrepreneurs (L26) |
| Capital gains taxation (H24) | Incentives of entrepreneurs and employees of startup firms (L26) |
| Capital gains taxation (H24) | Supply of funds to the venture industry (G24) |
| Capital gains taxation (H24) | Demand for venture funds (G24) |