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Wednesday, November 9, 2016

Morse & Allen:  Innovation And Taxation At Start-Up Firms

Susan C. Morse (Texas) & Eric J. Allen (USC), Innovation and Taxation at Start-Up Firms, 69 Tax L. Rev. ___ (2016):

This Article considers capital-constrained start-up firms and conventional income tax breaks meant to encourage innovation. Some argue that these tax breaks provide benefits to encourage innovation that are more certain and earlier in time compared to other possible government policies, such as patent protection. But start-up firms generally cannot use income tax breaks currently, because such firms are not profitable for years after their founding. Instead, investment in income tax planning reduces the funds available to a capital-constrained start-up firm for business investment. This reduces the time a firm has to reach its next stage of success, such as securing external financing.

To explore the experience of capital-constrained start-up firms and tax breaks for innovation, we provide and illustrate a model based on empirical data. We show that, depending on factors including endowment and cash burn rate, a start-up firm would rationally choose not to invest even modest amounts in tax planning. Our model suggests that conventionally designed tax policies are unlikely to achieve the goal of encouraging innovation at start-up firms, particularly in the earliest stages of such firms’ existence.

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