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Taxes and Venture Capital Support

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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 effortput forth by either agent contributes to the firm’s success, but is not verifiable. Asa result, the market equilibrium is biased towards inefficiently low venture capitalsupport. The capital gains tax becomes especially harmful, as it further impairsadvice and causes a first-order welfare loss. Once the capital gains tax is in place,limitations on loss off-set may paradoxically contribute to higher quality of venturecapital finance and welfare. Subsidies to physical investment in VC-backed startupsare detrimental in our framework.Keywords: Venture capital, capital gains taxation, double moral hazard.JEL-Classification: D82, G24, H24, H25

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Christian Keuschnigg, Søren Bo Nielsen

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