Many venture capital investors are calling for tax relief to stimulate investment activity in Germany. A study by LMU Munich and TU Darmstadt examined the relationship between capital gains tax and willingness to invest—and came to surprising results.
To find out how the tax rate affects investment activity, Professor Dr. Carolin Bock from TU Darmstadt and Dr. Martin Watzinger from LMU Munich examined 61,000 investments in 34,000 startups from 32 countries. Carolin Bock says:
“The starting point for the study was that we wanted to quantify the negative financing effects for startups caused by a high tax burden on venture capitalists.”
As expected, the study concludes that a higher tax rate dampens access to venture capital. Martin Watzinger says:
"The effect is substantial. On average, approximately 17.4 startups per ten million inhabitants in Germany receive their first round of venture capital funding each year. Our results show that a tax increase of one percentage point results in approximately 1.4 fewer startups per ten million inhabitants receiving initial funding."
High tax rates have an “educational effect”
In addition to the number of startup financings, the researchers also examined the companies' success and made an unexpected discovery: With higher tax rates, the proportion of successful startups increases. Because VC investors have less money at their disposal, they presumably use it more prudently.
“What’s interesting is that venture capitalists can actually assess the success DNA of startups and efficiently invest resources that are becoming scarcer due to taxes,”
says Bock.
“Since higher tax rates therefore mean that the more successful startups, which are so important for innovation, are financed first, one could almost say that tax increases have an educational effect,”
says Watzinger.
Nevertheless, the study authors do not recommend high tax rates: capital gains tax generally has a negative effect on the financing of startups.
