VENTURE CAPITAL AND CAPITAL GAINS TAXATION

The need to encourage venture capital is often adduced as an important justification for reducing the capital gains tax rate. For example, Norman Ture writes that For both outside investors and entrepreneurs [in new businesses] the reward sought is primarily an increase in the value of the equity investment. For outside investors in particular, it is important to be able to realize the appreciated capital and to transfer it into promising new ventures. Raising the tax on capital gains blunts the inducement for undertaking these ventures. This paper investigates the links between capital gains taxation and the amount of venture capital activity. It provides a framework for analyzing the channels through which tax policy affects start-up firms. The first section presents time-series data on venture capital invest-ment hi the United States. Beyond the well-known observation that venture investment increased in the early 1980s, perhaps coincidentally after the capital gains tax reduction of 1978, this section compares the growth rate of venture capital activity in the United States, Britain, and Canada. The U.S. venture industry expanded much more quickly tha