Tax credits for angels?

December 22, 2010

Xconomy reports that Michigan has decided to offer tax credits to angel investors. We’ve written on the topic here, and also recapped Rhys William’s testimony (before Florida Senator George LeMieux’s “Innovation in America: Opportunities and Obstacles” hearing) on the subject here. Scott Shane, Professor of Entrepreneurial Studies at Case Western Reserve University, argues in BusinessWeek that such tax credits are not the most ideal way to promote entrepreneurship because they redirect the same pool of available dollars to the same universe of start-ups, but in an inefficient manner – costing the state tax revenue while not maximizing job creation. Professor Shane prefers more broad-based tax relief:

Much as I would like to see policymakers encourage more high-growth entrepreneurial activity, I don’t believe that an angel tax credit for SBIR recipients is the way to do it. A capital gains tax cut for shareholders in startups (including angel investor holders of equity) would stimulate more high-growth entrepreneurship with fewer adverse effects than the proposed angel tax credit.

While we agree that broad-based tax relief (for any economic issue) tends to be a more efficient solution than targeted credits, it’s important to support any and all politically feasible means to make early stage investing more attractive.   Robert Ackerman, managing director of Allegis Capital, in a widely quoted interview, cites data from the National Science Foundation that illuminate why:

In 1981, 70.7% of industrial R&D took place at companies with 25,000 employees or more.  By 2005 that had fallen to 37.6%.  At the same time,  companies with fewer than 5,000 employees accounted for 39.6% of industrial R&D in 2005, up from 10.5% in the early 1980s.

From the same data we learn that companies with fewer than 500 employees account for just 11% of sales (of R&D-performing firms) while employing 25% of the scientists and engineers.  The large (>25,000) firms enjoy 43% of sales while employing only 29% of the scientists and engineers. Over the past three decades it has become more common for small companies to plant while large companies harvest – often by acquiring the same small companies in order to create economies of scale for the innovation.  This is a good change for the economy, and fueled in no small part by the growth and success of angel investors (and venture capital firms) who allocate capital more efficiently.  These activities should be encouraged with tax credits, rate reductions… or both.

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