Tax policy and interregional competition for mobile venture capital by the creative class

Abstract

We study how tax policy affects the competition for venture capital by the creative class in two regions A and B. The creative class in each region produces a final good with venture capital and creative capital. Venture capital moves freely between the two regions and the representative creative class member in each region has access to an initial amount of venture capital. Each region taxes venture capital at a particular rate and the tax revenue is paid out as a transfer to the representative creative class member. In this setting, we perform five tasks. We begin by determining the first-best tax rates in the two regions. Second, we solve for the net price of venture capital and then express the objective function that is to be maximized in each region as a function of this price. Third, we compute the first-order necessary conditions that describe the optimal tax rates in the two regions and show that the sign of the tax rate depends on the net exporting position of the region. Fourth, for specific parameter values, we calculate the two tax response functions and discuss their properties. Finally, we compute the two equilibrium taxes as a function of the model’s key parameters and show that these taxes must be of opposite signs.