Tax Policy, Venture Capital, and Entrepreneurship

The paper studies the effects of tax policy on venture capital activity. Entrepreneurs pursue a single high risk project each but have no own resources. Financiers provide funds, covering investment cost plus an upfront payment, in exchange for a share in the firm. The contract must include incentives to enlist full effort of entrepreneurs. Venture capitalists also assist with valuable business advice to enhance survival chances. The paper develops a general equilibrium framework with a traditional and an entrepreneurial sector and investigates the effects of taxes on the equilibrium level of managerial advice, entrepreneurship and welfare. It considers differential wage and capital income taxes, a comprehensive income tax, progressive taxation as well as investment and output subsidies to the entrepreneurial sector.