Edward Conard

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Upside of Inequality Oxford Unintended Consequences

AI Summary. Taxing unrealized capital gains reduces average founder ownership at exit by ~25% but raises the share of entrepreneurs with positive payoffs from ~16% to ~47%, because tax credits on failed ventures provide insurance that partly offsets dilution costs.

Eduardo Azevedo, Florian Scheuer, Kent Smetters and Min Yang National Bureau of Economic Research
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~84% of venture backed founders end with zero exit value, while the top 2% capture ~80% of total exit value. Accrual-based taxation would reduce mean founder ownership stakes at exit by ~25%, but with fully refundable tax credits, raise the share of founders with >0 payoffs to ~47%.

Does taxing unrealized gains help or hurt entrepreneurial risk-taking?

Core argument: Accrual-based capital gains taxation reduces founder ownership by ~25% at exit vs. realization-based taxation, yet increases positive payoff probability from.

This paper examines how taxing unrealized capital gains affects entrepreneurship, combining a dynamic career-choice model with new evidence on all U.S. venture capital backed startups. Figure 1a plots a histogram of the positive company exit values. The distribution spans several orders of magnitude and is relatively similar to a lognormal, but with a right skew and fatter right tail. A stylized model highlights a key trade-off: accrual-based capital gains taxes dilute successful founders by forcing additional share sales before exit, a well known concern, yet they also provide insurance through tax credits to founders whose ventures fail, an aspect often overlooked. Quantitatively, advance taxation substantially reduces founders' ownership at exit: average founder shares fall about 25% under accrual-based taxation relative to realization based taxation. At the same time, accrual taxation increases the fraction of entrepreneurs with positive payoffs from around 16% to nearly 47%. Embedding these outcomes in a career-choice framework shows that the insurance value of accrual taxation partly offsets dilution costs: less risk-averse founders favor realization-based taxes, while more risk averse ones prefer accrual-based taxes. The strength of this insurance channel depends on the highly skewed distribution of entrepreneurial payoffs and the design of loss provisions under accrual-based taxation.

Takeaways by Macro Roundup® AI

  1. Accrual-based capital gains taxation reduces founder ownership by ~25% at exit vs. realization-based taxation, yet increases positive payoff probability from.
  2. Risk-averse entrepreneurs prefer accrual taxation’s loss provisions despite ownership dilution, while less risk-averse founders favor realization-based taxation, driving heterogeneous career.
  3. Accrual taxation’s insurance channel partly neutralizes dilution costs by expanding the fraction of founders achieving positive returns, demonstrating that tax.

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