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Venture Capital and Capital Gains Taxation

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  • 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.
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Suggested Citation

  • James M. Poterba, 1988. "Venture Capital and Capital Gains Taxation," Working papers 508, Massachusetts Institute of Technology (MIT), Department of Economics.
  • Handle: RePEc:mit:worpap:508
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    References listed on IDEAS

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    1. Stiglitz, Joseph E., 1983. "Some aspects of the taxation of capital gains," Journal of Public Economics, Elsevier, vol. 21(2), pages 257-294, July.
    2. James M. Poterba, 1986. "How Burdensome are Capital Gains Taxes?," NBER Working Papers 1871, National Bureau of Economic Research, Inc.
    3. Alan J. Auerbach, 1988. "Capital Gains Taxation in the United States: Realizations, Revenue, and Rhetoric," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(2), pages 595-638.
    4. Poterba, James M., 1987. "How burdensome are capital gains taxes?: Evidence from the United States," Journal of Public Economics, Elsevier, vol. 33(2), pages 157-172, July.
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