How should taxes be designed to encourage entrepreneurship?

Abstract

This paper examines how tax policy should be designed to best encourage entrepreneurial activity in start-up firms. We begin by describing several presumed market failures affecting entrepreneurial firms that would lead to an under-provision of entrepreneurial activity: 1) information spillovers from innovations in entrepreneurial firms to other firms, 2) positive externalities to consumers from innovative new products sold by these firms, and 3) lemons problems in the market for both debt and equity issued by these firms. We then analyze the degree to which various tax policy measures can alleviate these failures. A key complication we focus on is the inability of the government to observe which, and the degree to which, any given start-up firm is entrepreneurial. This forces policy to target behavioral differences between entrepreneurial and non-entrepreneurial start-ups. We presume that start-up firms, to the degree they are entrepreneurial, face upfront costs in developing and marketing a new technology, and in the process face substantial risk. Our analysis then suggests the use of refundable tax savings from business losses in start-ups together with a compensating surtax on the profits of startups (needed in the case of lemons problems) to help alleviate the various market failures faced by entrepreneurial start-ups.

Intertemporal income shifting and the taxation of owner-managed businesses

“…It is likely that there are externalities related to some closely-held businesses (for example, related to trials of innovative new ideas), such that the market produces too few start-ups and too little subsequent investment. However, lower rates of tax on capital incomes are poorly targeted at addressing market failures associated with entrepreneurship (Gordon and Sarada (2018)). On some margins, the lower rates do not change investment incentives at all.…”

“…Policy makers often go further than trying to avoid discouraging investment by supporting lower capital (relative to labour) tax rates as a way to promote greater investment in small businesses. Although there are market failures associated with such investment, they are poorly targeted by the types of tax policies that tend to be used in practice, including preferential rates on capital gains (Mirrlees et al (2011), Gordon and Sarada (2018)), which opens the possibility of taxes leading to a misallocation of capital (for example towards the small business sector).…”

Tax Progressivity and Entrepreneurial Dynamics

“…A key challenge faced in the literature has been to develop a concrete measure of "entrepreneurial activity" [22,23]. This paper is focused on the transition phase, when nascent entrepreneurs develop into operational businesses.…”

The Analysis of imposition, deposit and reporting of value-added tax by PT. Seimitsu Diagnostics

“…If the Output Tax is less than the Input Tax, so the difference is the compensated tax excess to the next Tax Period. While, if the Output Tax is bigger than the Input Tax, then the difference is underpayment value-added tax that must be paid by the Taxable Enterprises (Gordon, 2018;Harju et al, 2019;Olsen et al, 2019;Scheuer & Werning, 2017).…”