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- cost-investment incentives, including tax breaks or exemptions for investors on income received from their investment on a venture capital institution, or on net capital gains upon dissolution of the institution, and specially favorable regimes allowing use of capital losses incurred to offset capital gains or ordinary income (.e.g. the U.K.).

Overall, the analysis of caDital gains tax Policv has been one of the most important centers of attention in both practitioners' and academic circles. Most writings give conceptual support to the idea that capital gain tax reductions or exemptions would favor the venture capital industry. For instance, many consider that in the U.S. the 1978 and 1981 capital gain tax reductions were among the key determinants of the expansion in the volume of funds available to the industry (see Pratt (1981) and Premus (1984), for example).

The results in Poterba (1989), however, call for a more cautious approach to the issue. In his di cussion of the potential impact of capital gain tax changes on venture capital Poterba focuses on two separate issues, effects that would work through the supply of venture funds, and effects that would operate via the demand for venture funds. On the supply side, Poterba presents evidence that in the U.S. more than 80 percent of the funding for venture capital projects is from investors who are not affected by the personal income tax. Consequently, a cut in capital gains tax rates could not reasonably be expected to have a crucial role in promoting venture activity.

Further, Poterba (1989) reports data indicating the insignificance of capital gains on venture investments vis-a-vis total capital gains. Taking the dollar value of venture backed initial public offerings (IPOs) as a proxy for capital gains on venture investments, Poterba's data show that over the period 1983-1987, capital gains on venture investment represent on average 1.1 percent of total capital gains. IPOs are likely to account for more than half of the capital gains on venture investments; but even assuming that the total amount of IPOs represent capital gains, and doubling such gains to get an oritimistic estimate, the ratio is still fairly insignificant. This suggests that while a systematic reduction in capital gains tax rates would most likely lead to a revenue loss<sup>39</sup> , it would most significantly benefit investors in assets besides venture capital firms, leaving the total tax burden on venture capital financiers basically unchanged.

However, capital gain taxation could be relevant for the level of start-up activity, and affect the venture capital industry via the demand for funds. It appears reasonable to assume that most potential entrepreneurs are faced with the option of either working as middle or high level managers for large firms, or setting their own firms with a leading executive position. Since their compensation is likely to involve a larger share of capital gains 39 Some supporters backed President Bush's proposal to reduce the maximum rate of tax on long-term gains on the rationale that the tax cut would ultimately increase total revenues. Auerbach (1989) presents an interesting discussion on the debates generated by the proposal, and the improbability of the "increasing-revenues" scenario.