Capital Gains Taxes and Entrepreneurship: Analyzing the Dilution vs. Risk-Taking Effects
By
hhs
Master baker tier. Every paragraph earns its place on the tray.
Summary
This research paper examines how capital gains taxes affect entrepreneurship through two competing channels: the 'dilution effect' where higher taxes reduce returns and discourage entrepreneurship, and the 'risk-taking effect' where higher taxes reduce the downside risk of failure and encourage entrepreneurship. The authors develop a theoretical model showing that the net effect depends on entrepreneurs' risk aversion and the tax system's progressivity. They find that capital gains taxes can actually increase entrepreneurship for risk-averse individuals, challenging conventional wisdom that lower taxes always spur entrepreneurial activity.
Key quotes
· 5 pulledThe conventional wisdom is that lower capital gains taxes spur entrepreneurship by increasing the after-tax returns to successful ventures.
We identify two competing channels through which capital gains taxes affect entrepreneurship: the dilution effect and the risk-taking effect.
The dilution effect reduces the after-tax return to successful entrepreneurship, discouraging entry.
The risk-taking effect reduces the downside risk of entrepreneurship, encouraging entry.
Our model shows that the net effect of capital gains taxes on entrepreneurship depends on entrepreneurs' risk aversion and the progressivity of the tax system.
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