This study examines whether Japan’s tax system is efficiently designed to promote innovation in start-ups.

　First, we explore the justification for tax incentives to promote innovation. Tax incentives can be justified when one of the following exists: (1) an undersupply of innovation due to its positive externality; (2) restrictions on start-ups’ access to financing due to information asymmetry; and (3) structural distortions of the basic tax system due to the progressive tax rate structure, the double taxation of corporate profits, and the realization principle of capital gains taxation. Next, we highlight some pressure points to consider when designing tax incentives for innovation by referring to theoretical studies and developments in tax policy and practices in the United States.

　The challenges of Japan’s tax policy for innovation include the following: (1) start-ups seldom benefit from various tax incentives for innovation due to the lack of tax refundability for losses and research and development (R&D) tax credits, which have a limited carryforward period, and strict legislative and judicial restrictions on the transfer of tax attributes; (2) historically layered revisions of the system make it too complicated to be used by start-ups, whose time and financial resources are limited; and (3) the policy on entrepreneurs’ entry and exit strategies is inconsistent with the ideal of progressive taxation in the personal income tax system, although Japan’s tax system is designed to encourage entry by allowing the conversion of labor income into capital gains on stocks, thereby easing the success tax on entrepreneurs and mitigating the lock-in effect in the exit stage.