Tax the Eggs, not the Hen

Abstract

The VC industry provides an excellent example for an industry that is based on the ability to bring together ideas and high-risk capital in a process that generates value. Of particular interest is the case where the entrepreneurs reside in one country and the investors reside in another country. There are two types of benefits. The first type of benefits depends on the success of the young innovative technology firms. The second type of benefits depends on the total flow of high-risk capital from the country of the investors to the country where the investment takes place. While the benefits to the entrepreneurs and the shareholders are vastly discussed, the benefit to the hosting country is less explored. Successful entrepreneurs earn a lot of money in case of success. The high gains attract public pressure for higher and more effective capital gains tax. In this work we show that this to be a worthless and even harming. We show that the benefits are both direct in the form of taxes and indirect as higher wages. We use hand-picked database to estimate the total benefit to a small country that was successful in attracting international VC funding. Our main result is that the Income tax collected from VC backed employees is 10.7 higher than the Capital tax gained from exits. The call for the taxation of capital gains of the wealthy individuals could materially hurt the revenue of the hosting country