QSBS Incentives Drive Early-Stage Funding and Innovation
A 2023 academic study by Joan Farre-Mensa and Jun Chen (University of Illinois), titled “Capital Gains Tax Relief and Entrepreneurship: Evidence from the QSBS Exemption,” offers some of the most rigorous evidence to date on how capital gains tax policy affects entrepreneurship and innovation in the U.S.
Focusing on the expansion of the Qualified Small Business Stock (QSBS) exemption, the authors found that favorable capital gains treatment significantly alters early-stage financing outcomes and drives measurable gains in innovation output.
Startups eligible for QSBS treatment were 30% more likely to receive first-round venture capital funding, with that figure rising to 43% for R&D-intensive firms. These effects are concentrated in the seed and Series A stages, where capital is often the scarcest.
The study also finds that QSBS eligibility leads to higher rates of innovation. Eligible firms file 14% more patents and receive 10% more citations over a five-year period, suggesting not only increased output but also higher-impact technological development. Angel investment is 23% more likely to occur in QSBS-eligible startups, with the effect most pronounced in high-risk sectors such as technology and life sciences.
In addition to investor behavior, the authors document firm-level responses to eligibility requirements. Many startups near the $50 million asset threshold actively manage their balance sheets to remain within the cap. This clustering below the cutoff implies that the incentive is strong enough to influence real economic decisions around asset accumulation, financing, and growth timing.
“These findings provide the first direct evidence that the 2010 QSBS expansion increased entrepreneurship and innovation,” the authors write. Their results point to capital gains tax relief not just as a post-liquidity benefit, but as a forward-looking policy tool that drives capital formation in underserved parts of the market.
Despite its impact, QSBS remains underutilized. Separate Treasury data shows that from 2012 to 2022, the median exclusion claimed by individual taxpayers was under $3,000. This suggests that many eligible participants either lack awareness or do not meet the five-year holding requirement. Nonetheless, QSBS has remained a rare point of bipartisan consensus, with expansions enacted under both Democratic and Republican administrations.
As policymakers consider the future of tax policy in an era of slowing productivity growth and rising capital costs, the evidence suggests that targeted capital gains exclusions like QSBS can play a meaningful role in directing investment toward the kinds of high-risk, high-reward ventures that drive innovation and long-term growth.
