Direct Subsidy or Tax Break? The Impact of Loss Aversion in Choosing Incentives for Entrepreneurs.

Abstract

Across three studies, we found that direct subsidies were more effective than tax breaks in encouraging prospective entrepreneurs. Nevertheless, people who were asked to choose the policy that would encourage more entrepreneurial behavior showed indifference between the use of tax breaks and direct subsidies as a means to that end. Entrepreneurs favored direct subsidies because they felt that direct subsidies would better minimize potential losses. Meanwhile, policy-makers were more willing to adopt tax breaks because they believed tax breaks were more effective in minimizing an entrepreneur’s potential losses. Together, these studies provide evidence that direct subsidies are more effective than tax breaks when encouraging entrepreneurial behavior, point to a psychological asymmetry between policy- makers and their constituents that has serious consequences, and open up new paths for future research.