IDEAS home Printed from https://ideas.repec.org/a/mof/journl/ppr20_01_01.html
   My bibliography  Save this article

Designing a Tax System that Encourages Innovation in Start-ups

Author

Listed:
  • Takayuki Nagato

    (Professor, Faculty of Law, Gakushuin University)

Abstract

This study examines whether Japan's tax system is efficiently designed to promote innovation in start-ups. First, we explore the justification for tax incentives to promote innovation. Tax incentives can be justified when one of the following exists: (1) an undersupply of innovation due to its positive externality; (2) restrictions on start-ups' access to financing due to information asymmetry; and (3) structural distortions of the basic tax system due to the progressive tax rate structure, the double taxation of corporate profits, and the realization principle of capital gains taxation. Next, we highlight some pressure points to consider when designing tax incentives for innovation by referring to theoretical studies and developments in tax policy and practices in the United States. The challenges of Japan's tax policy for innovation include the following: (1) start-ups seldom benefit from various tax incentives for innovation due to the lack of tax refundability for losses and research and development (R&D) tax credits, which have a limited carryforward period, and strict legislative and judicial restrictions on the transfer of tax attributes; (2) historically layered revisions of the system make it too complicated to be used by start-ups, whose time and financial resources are limited; and (3) the policy on entrepreneurs' entry and exit strategies is inconsistent with the ideal of progressive taxation in the personal income tax system, although Japan's tax system is designed to encourage entry by allowing the conversion of labor income into capital gains on stocks, thereby easing the success tax on entrepreneurs and mitigating the lock-in effect in the exit stage.

Suggested Citation

  • Takayuki Nagato, 2024. "Designing a Tax System that Encourages Innovation in Start-ups," Public Policy Review, Policy Research Institute, Ministry of Finance Japan, vol. 20(1), pages 1-33, February.
  • Handle: RePEc:mof:journl:ppr20_01_01
    DOI: 10.57520/prippr.20-1-1
    as

    Download full text from publisher

    File URL: https://doi.org/10.57520/prippr.20-1-1
    Download Restriction: no

    File URL: https://libkey.io/10.57520/prippr.20-1-1?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Erik Hurst & Benjamin Wild Pugsley, 2011. "What Do Small Businesses Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 42(2 (Fall)), pages 73-142.
    2. Fried, Jesse M. & Ganor, Mira, 2006. "Agency Costs of Venture Capitalist Control in Startups," Berkeley Olin Program in Law & Economics, Working Paper Series qt5rz3w67b, Berkeley Olin Program in Law & Economics.
    3. Schumpeter, Joseph A., 1947. "The Creative Response in Economic History," The Journal of Economic History, Cambridge University Press, vol. 7(2), pages 149-159, November.
    4. Mitsuru Igami, 2017. "Estimating the Innovator’s Dilemma: Structural Analysis of Creative Destruction in the Hard Disk Drive Industry, 1981–1998," Journal of Political Economy, University of Chicago Press, vol. 125(3), pages 798-847.
    5. Evsey D. Domar & Richard A. Musgrave, 1944. "Proportional Income Taxation and Risk-Taking," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 58(3), pages 388-422.
    6. Mary Brooke Billings & Kevin Hsueh & Melissa F. Lewis-Western & Gladriel Shobe, 2023. "Innovations in IPO Deal Structure: Do Up-C IPOs Harm Public Shareholders?," Management Science, INFORMS, vol. 69(5), pages 3048-3079, May.
    7. Cullen, Julie Berry & Gordon, Roger H., 2007. "Taxes and entrepreneurial risk-taking: Theory and evidence for the U.S," Journal of Public Economics, Elsevier, vol. 91(7-8), pages 1479-1505, August.
    8. Gordon, Roger & Sarada,, 2018. "How should taxes be designed to encourage entrepreneurship?," Journal of Public Economics, Elsevier, vol. 166(C), pages 1-11.
    9. Eric Toder, 2020. "Does the Federal Income Tax Law Favor Entrepreneurs?," National Tax Journal, National Tax Association;National Tax Journal, vol. 73(4), pages 1219-1232, December.
    10. Kaplow, Louis, 1994. "Taxation and Risk Taking: A General Equilibrium Perspective," National Tax Journal, National Tax Association, vol. 47(4), pages 789-98, December.
    11. Kaplow, Louis, 1994. "Taxation and Risk Taking: A General Equilibrium Perspective," National Tax Journal, National Tax Association;National Tax Journal, vol. 47(4), pages 789-798, December.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Louis Kaplow, 2024. "Optimal Income Taxation," Journal of Economic Literature, American Economic Association, vol. 62(2), pages 637-738, June.
    2. Elert, Niklas & Henrekson, Magnus & Stenkula, Mikael, 2017. "Institutional Reform for Innovation and Entrepreneurship: An Agenda for Europe," Working Paper Series 1150, Research Institute of Industrial Economics, revised 16 Feb 2017.
    3. Magnus Henrekson & Dan Johansson & Mikael Stenkula, 2010. "Taxation, Labor Market Policy and High-Impact Entrepreneurship," Journal of Industry, Competition and Trade, Springer, vol. 10(3), pages 275-296, September.
    4. Dirk Schindler, 2008. "Taxing Risky Capital Income - A Commodity Taxation Approach," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 64(3), pages 311-333, September.
    5. Auerbach, Alan J., 2006. "The Choice between Income and Consumption Taxes: A Primer," Department of Economics, Working Paper Series qt9q85f6qz, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    6. Robin Boadway & Kevin Spiritus, 2021. "Optimal Taxation of Normal and Excess Returns to Risky Assets," Tinbergen Institute Discussion Papers 21-025/VI, Tinbergen Institute.
    7. Louis Kaplow, 2020. "A Unified Perspective on Efficiency, Redistribution, and Public Policy," NBER Working Papers 26683, National Bureau of Economic Research, Inc.
    8. Orkhan Nadirov & Bruce Dehning, 2020. "Tax Progressivity and Entrepreneurial Dynamics," Sustainability, MDPI, vol. 12(9), pages 1-21, April.
    9. Ergete Ferede, 2021. "Entrepreneurship and personal income tax: evidence from Canadian provinces," Small Business Economics, Springer, vol. 56(4), pages 1765-1781, April.
    10. Louis Kaplow, 2019. "Market Power and Income Taxation," NBER Working Papers 25578, National Bureau of Economic Research, Inc.
    11. Boar, Corina & Knowles, Matthew, 2024. "Optimal taxation of risky entrepreneurial capital," Journal of Public Economics, Elsevier, vol. 234(C).
    12. Devereux, Michael, 2003. "Taxing Risky Investment," CEPR Discussion Papers 4053, C.E.P.R. Discussion Papers.
    13. Alan J. Auerbach, 2006. "Who Bears the Corporate Tax? A Review of What We Know," NBER Chapters, in: Tax Policy and the Economy, Volume 20, pages 1-40, National Bureau of Economic Research, Inc.
    14. Sialm, Clemens, 2006. "Stochastic taxation and asset pricing in dynamic general equilibrium," Journal of Economic Dynamics and Control, Elsevier, vol. 30(3), pages 511-540, March.
    15. Sims, Theodore S., 2015. "Income taxation, wealth effects, and uncertainty: Portfolio adjustments with isoelastic utility and discrete probability," Economics Letters, Elsevier, vol. 135(C), pages 52-54.
    16. Catherine, Sylvain, 2022. "Keeping options open: What motivates entrepreneurs?," Journal of Financial Economics, Elsevier, vol. 144(1), pages 1-21.
    17. Magnus Henrekson & Tino Sanandaji, 2018. "Stock option taxation: a missing piece in European innovation policy?," Small Business Economics, Springer, vol. 51(2), pages 411-424, August.
    18. Francesco Menoncin & Paolo M. Panteghini, 2013. "The Johansson-Samuelson Theorem in General Equilibrium: A Rebuttal," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 69(1), pages 57-71, March.
    19. Henrekson, Magnus & Sanandaji, Tino, 2016. "Stock Option Taxation and Venture Capital Activity: A Cross-Country Comparison," Working Paper Series 1104, Research Institute of Industrial Economics, revised 09 Nov 2017.
    20. Poterba, James M., 2002. "Taxation, risk-taking, and household portfolio behavior," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 17, pages 1109-1171, Elsevier.

    More about this item

    Keywords

    tax and risk taking; R&D tax credits; Tax Receivable Agreements (TRAs); capital gains taxation; IPO; M&A;
    All these keywords.

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • K34 - Law and Economics - - Other Substantive Areas of Law - - - Tax Law
    • O38 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Government Policy

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:mof:journl:ppr20_01_01. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Policy Research Institute (email available below). General contact details of provider: https://edirc.repec.org/data/prigvjp.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.