Taxation, Innovation, and Entrepreneurship

Abstract

We examine the public provision and financing of basic research. While basic research is a public good benefiting innovating entrepreneurs, the provision and financing also affect the entire economy: occupational choices of potential entrepreneurs, wages of workers, dividends to shareholders, and aggregate output. We show that the general economy impact of basic research rationalizes a pecking order of taxation to finance basic research. In particular, in a society with desirable dense entrepreneurial activity, a large share of funds for basic research should be financed by labor taxation and a minor share is left to profit taxation. Such tax schemes induce a significant share of agents to become entrepreneurs, thereby rationalizing substantial investments in basic research that fosters their innovativeness. These entrepreneurial economies, however, may make a majority of workers worse off. In such circumstances, stagnation may prevail.