Tax Policy and Entrepreneurship in the Presence of Asymmetric Information in Capital Markets

34 Pages Posted: 14 Apr 2003

See all articles by Clemens Fuest

Clemens Fuest

ifo Institute – Leibniz Institute for Economic Research at the University of Munich; Ludwig-Maximilians-University, Munich; Center for Economic Studies (CES)

Bernd Huber

Ludwig Maximilian University of Munich (LMU) - Staatswirtschaftliches Institut; CESifo (Center for Economic Studies and Ifo Institute)

Philipp Tillessen

Kreditanstalt für Wiederaufbau (KFW)

Date Written: February 2003

Abstract

This paper considers the implications of asymmetric information in capital markets for entrepreneurial entry and tax policy. In many countries, governments subsidize the creation of new firms. One possible justification for these subsidies is that capital markets for the financing of new firms do not function properly. We analyse this issue by assuming that entrepreneurs need outside financing for their projects and know more about the quality of their projects than outside investors. Entrepreneurs have the choice between carrying out their entrepreneurial projects or working as an employee. It turns out that asymmetric information in capital markets leads to too much rather than too little entrepreneurial entry. Therefore, the optimal tax policy should discourage rather than subsidize entrepreneurial entry. We also analyse the welfare effects of project screening and show that there is too much screening. Our policy conclusion is that subsidies for the foundation of firms must be based on reasons other than informational asymmetries in capital markets.

JEL Classification: H21, G14, G32

Suggested Citation

Fuest, Clemens and Huber, Bernd and Tillessen, Philipp, Tax Policy and Entrepreneurship in the Presence of Asymmetric Information in Capital Markets (February 2003). CESifo Working Paper Series No. 872. Available at SSRN: https://ssrn.com/abstract=385720

Clemens Fuest (Contact Author)

ifo Institute – Leibniz Institute for Economic Research at the University of Munich

Poschinger Str. 5
Munich, DE 81679
Germany
++89-9224-1430 (Phone)

Ludwig-Maximilians-University, Munich ( email )

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Germany

Center for Economic Studies (CES) ( email )

Schackstr. 4
Munich, DE 80539
Germany
++89 2180-2748 (Phone)
++89 2180-17845 (Fax)

Bernd Huber

Ludwig Maximilian University of Munich (LMU) - Staatswirtschaftliches Institut ( email )

Ludwigstrasse 28/III VG
D-80799 Munich
Germany
+49 89 2180-2874 (Phone)
+49 89 2180-3128 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Philipp Tillessen

Kreditanstalt für Wiederaufbau (KFW) ( email )

Palmengartenstrasse 5-9
60325 Frankfurt am Main
Germany

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