Taxes and Venture Capital Support
38 Pages Posted: 28 Jan 2004
Date Written: December 2003
In this paper we set up a model of start-up finance under double moral hazard. Entrepreneurs lack own resources and business experience to develop their ideas. Venture capitalists can provide start-up finance and commercial support. The effort put forth by either agent contributes to the firm's success, but is not verifiable. As a result, the market equilibrium is biased towards inefficiently low venture capital support. The capital gains tax becomes especially harmful, as it further impairs advice and causes a first-order welfare loss. Once the capital gains tax is in place, limitations on loss offset may paradoxically contribute to higher quality of venture capital finance and welfare. Subsidies to physical investment in VC-backed startups are detrimental in our framework.
Keywords: venture capital, capital gains taxation, double moral hazard.
JEL Classification: D82, G24, H24, H25
Suggested Citation: Suggested Citation