Want to Fund Startups? Look to Tax Break

Eliminating capital gains taxes on investment in small business could get the Benjamins flowing to startups.

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Eliminating capital gains taxes on investments in startups should help these companies raise more money, but how much?

The Kauffman Foundation has an answer: an additional $7.5 billion over 10 years.

That’s according to an analysis conducted by the Kansas City-based foundation, which specializes in entrepreneurship. The study is timely because pending legislation in Congress, which is backed by President Barack Obama, would permanently eliminate capital gains taxes on investments in C corporations with less than $50 million in assets.

Kauffman’s estimate of how much additional investment this tax break would generate is based on how much money venture capitalists, angel investors,, and entrepreneurs themselves currently invest in startups that are C corporations. In 2010, that number was around $10 billion. Exempting these investments from the current 15 percent capital gains tax rate should lead to a 7.5 percent increase in total investment in these startups, Kauffman estimates.

Increasing investments in startups should pay off in job growth, because startups “contribute the vast majority of net new jobs created in the U.S. economy,” said Robert Litan, a coauthor of the study and vice president of research and policy for the Kauffman Foundation.

“Measures that would channel substantially more investment in startups should lead to the launch of more high-growth firms and boost the odds that they will reach the growth phase and create jobs that will support economic recovery,” said study co-author Alicia Robb, a senior research fellow at Kauffman.

Until 2009, taxpayers could exclude 50 percent of their gains from the sale of stock in qualified small businesses from capital gains taxes. The economic stimulus bill temporarily increased that percentage to 75 percent, and then additional legislation raised it to 100 percent for stock in qualified small businesses acquired before the end of 2011.

It’s hard to tell how much additional investment these capital gains tax breaks created because this small-business stock must be held for five years in order to qualify for the break. Obama has proposed additional enhancements to make these investments even more attractive: making the capital gains tax break exempt from the alternative minimum tax and giving investors six months to roll over their gains into new investments in small businesses.