Dilution vs. Risk taking: Capital gains taxes and entrepreneurs
Recorded: Nov. 30, 2025, 1:04 a.m.
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Working Paper 34512 DOI 10.3386/w34512 Issue Date November 2025 Recent proposals to tax unrealized capital gains or wealth have sparked a debate about their impact on entrepreneurship. We show that accrual-based taxation creates two opposing effects: successful founders face greater dilution from advance tax payments, whereas unsuccessful founders receive tax credits that effectively provide insurance. Using comprehensive new data on U.S. venture capital deals, we find that founder returns remain extremely skewed, with 84% receiving zero exit value while the top 2% capture 80% of total value. Moving from current realization-based to accrual-based taxation would reduce founder ownership at exit by 25% on average but would also increase the fraction receiving positive payoffs from 16% to 47% when tax credits are refunded. Embedding these distributions in a dynamic career choice model, we find that founders with no or moderate risk aversion prefer the current realization-based tax system, while more risk-averse founders prefer accrual-based taxation. We estimate that a 2% annual wealth tax has a similar impact on dilution as taxing unrealized capital gains but produces no risk-sharing benefits due to the absence of tax credits in case of down rounds. Acknowledgements and Disclosures We thank Alan Auerbach, Frederick Bennhoff, Anmol Bhandari, David Burgherr, Harold Cole, Ashley Craig, Emanuel Hansen, Jonathan Heathcote, Xavier Jaravel, Louis Kaplow, Wojciech Kopczuk, Moritz Kuhn, Ellen McGrattan, Dominik Sachs, Emmanuel Saez, David Seim, Kjetil Storesletten, Harald Uhlig, Nicolas Werquin, Danny Yagan, Eric Zwick, and seminar participants at Australian National University, Barcelona, BU, CESifo, Chicago Fed, CREST, EEA, Frankfurt, Fribourg, LSE, Mannheim, Munich, NBER Public Economics, NHH Bergen, SED, Stockholm, Toronto, Vienna, Wharton, and Zurich for helpful discussions. Junlei Chen provided excellent research assistance. Florian Scheuer acknowledges support from SNSF Consolidator Grant No. 213673. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. Citation and Citation Data Copy Citation Eduardo M. Azevedo, Florian Scheuer, Kent Smetters, and Min Yang, "Dilution vs. Risk Taking: Capital Gains Taxes and Entrepreneurship," NBER Working Paper 34512 (2025), https://doi.org/10.3386/w34512. Copy to Clipboard Download Citation MARC RIS BibTeΧ Download Citation Data
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This NBER working paper, “Dilution vs. Risk Taking: Capital Gains Taxes and Entrepreneurship” by Azevedo, Scheuer, Smetters, and Yang, investigates the potential impact of shifting from a realization-based to an accrual-based tax system on capital gains, specifically within the context of entrepreneurship. The core argument centers on how this change would affect founder ownership and risk-taking behavior during venture capital deals. The study’s findings reveal a complex interaction between tax incentives and the inherent risks associated with startup ventures. The authors’ methodology relies on a comprehensive new dataset of U.S. venture capital deals, providing a granular examination of founder returns and exit valuations. Their analysis highlights the significantly skewed distribution of outcomes within the startup ecosystem: a substantial majority (84%) of founders receive zero exit value, while only the top 2% capture 80% of total value. This stark disparity underscores the high-risk nature of entrepreneurial endeavors. Moving to an accrual-based tax system, where capital gains are taxed annually regardless of actual sale, introduces a novel dynamic. While the study predicts a 25% average reduction in founder ownership upon exit due to increased tax payments, it also generates tax credit benefits. Critically, the research demonstrates that this change would increase the percentage of founders receiving positive payouts from 16% to 47%, effectively providing a safety net against down rounds—situations where a company’s valuation decreases. The authors then incorporated these distributional effects into a dynamic career choice model. This model revealed a key insight: founders with low or moderate risk aversion strongly prefer the current, realization-based tax system, reflecting the preference for waiting for a successful exit. Conversely, more risk-averse founders exhibit a preference for the accrual-based system because of the guaranteed tax credits, allowing them to absorb losses more comfortably. Notably, the study demonstrates that a 2% annual wealth tax, frequently proposed as a method of wealth taxation, has a similar impact on dilution as taxing unrealized capital gains. However, unlike a wealth tax, the accrual-based system does not offer risk-sharing benefits due to the absence of tax credits in conditions of a downround. This difference in outcome is largely controlled by the dynamic career choice model. The research concludes that the shift to accrual-based taxation would alter the risk and reward calculus for entrepreneurs. The study offers valuable insights for policymakers contemplating tax reforms aimed at influencing venture capital activity and the broader entrepreneurial landscape. It necessitates careful consideration of the distributional consequences and the potential impact on incentives within the crucial stage of startup funding and growth. |