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Lipservice (Bipartisan Pro-Growth Tax Policy Demagoguery)

Posted by VenturePopulist On November - 17 - 2010

GotthardLipservice[1]

In the State of the Union address earlier this year, President Obama acknowledged that “the true engine of job creation in this country will always be America’s businesses” and, that to spur the economy and job creation “we should start where most new jobs do – in small businesses” prior to declaring that we should “eliminate all capital gains taxes on small business investment”.

 

The result of this effervescent yet evanescent evangelism? Our lawmakers deliberated and subsequently concocted a legislative scheme to incentive private investment and job creation—that lasted all of 100 days!

 

That’s right. On September 27, of this year Obama signed into law the Small Business Jobs Act (H.R. 5297), which included among other provisions, a 100% exemption (subject to certain issuer limitations) of income from capital gains derived from investments in “qualified small business stock”. The 100% exclusion is an attempt to encourage investment in startups, early-stage companies and small businesses.

 

Blink and you would have missed it. The exemption expires on January 1, 2011, coincident with the expiration of the “Bush Tax Cuts” which raises capital gains tax rates at the highest bracket from 15% to 20%.

 

A critical (albeit secondary) purpose of tax policy is to encourage behavior that is deemed to be beneficial to the public interest. In this instance, our politicians pandered policy to promote employment and private investment. But, such that most private investors take at least 100 days to evaluate an opportunity, there was no way that this important revision in tax policy had the sufficient runway to effect any material changes in investor behavior. It was not actionable tax policy.

 

Few angel investors that I have spoken with were even aware of the exemption…and not a single offering out of a couple of dozen that I evaluated during this period pointed out the perk.  I wouldn’t be surprised if the legislative costs of negotiating and implementing this fleeting folly far exceeded any illusory benefits.

 

Policy penchants and partisan politics aside, politicians have extolled upon the virtues of no taxes on capital gains for the past 50 years. Prior to his tax cuts, President John Kennedy accurately asserted that “the tax on capital gains directly affects investment decisions, the mobility and the flow of risk capital…the ease or difficulty experienced by new ventures in obtaining capital, and thereby the strength and potential for growth in the economy.”

 

Most of our pols know intuitively that small business is the primary and most reliable engine of job creation. Irrefutably, two-thirds of net new jobs are created by companies with fewer than 500 employees.

 

This past August, a research study entitled, “Who Creates Jobs? Small vs. Large vs. Young further clarified that there is more to the equation than merely size. “Business startups contribute substantially to both gross and net job creation,” says John Haltiwanger, who co-authored the study along with the two economist from the Census Bureau, but, “it’s all age – startups are where the job creation really occurs.” Most job creation occurs in the early years of new companies.

 

Yet, government “stimulus” programs spend more resources attempting to promote bank lending (more of a benefit to existing business) than spurring private investment in risk-taking and entrepreneurialism.

 

Tactically, our tax policies need to do more today (and certainly beyond this coming January 1st) to incentivize angels investors to fund early-stage ventures than presently contemplated by our legislative class. Strategically, our restrictive tax policies put us at distinct disadvantages to industrialized countries such as Austria, Belgium, Germany, Mexico, New Zealand and others than have no taxes on capital gains, as well as, countries that do not impose capital gains on stocks such as Israel, Spain, China, Hong Kong, Singapore and most of the other Asian countries.

 

To its credit, Obama’s Small Business Jobs Act provided investors considering a qualifying venture investment with a significant opportunity as the result of the full 100% capital gains tax moratorium which also excluded 100% of the capital gains from alternative minimum tax (AMT) considerations.

 

Alas, the three-month window was unconscionable. Moreover, the act included such archaic prescriptions as; a five-year minimum required holding period, requirements that the business be a C-corporation, a greater of 10X or $10M cap, and, unnecessarily excluded certain labor-needy business categories such as hotels and restaurants.

 

In short, thos disappearing Jobs Act mirrored the myriad of misinformed, ill-conceived and insincere tax policy prescriptions of prior administrations.

 

But it may get even worse. Last week Obama’s bipartisan deficit commission released draft recommendations on a host of third-rail political issues including entitlement, discretionary and defense spending cuts and a variety of comprehensive tax simplifications and reforms. With lack of respect to capital gains, they would be taxed as ordinary income under each of the Bowles-Simpson reform scenarios. Since the rate is currently at 15 percent, that implies a doubling depending on the plan.

 

I have never angst over the notion of politicians breeding due to their inability to bifurcate the baby and the bathwater.

 

Tax policy must be designed to promote private investment in startups, stimulate job creation and the economy in a manner that is meaningful and immutable to the estimated 225,000 angel investors. I would concur with New York Times columnist Thomas Friedman’s recent proclamation that “we need three things: start-ups, start-ups and more start-ups,” and, that tax policy should incentivize “our best minds to be able to make a killing from starting new companies rather than going to Wall Street and making a killing by betting against existing companies.”

 

During the economic downturn in the mid-1990s entrepreneurs created 3.8 million new jobs. If the genuine intent of tax policy is promote entrepreneurship and to encourage more risk-taking by private investors there should be a bipartisan consensus among politicians to eschew slippery slope suspicions and disingenuous diatribes that such targeted capital gains tax reform only reward the “wealthy”.

 

It is time to get down to small business. Venture Populist proposes specific and targeted tax reform such that;

 

  • There would be no capital gains taxes on investments in startup or pre-revenue companies – to encourage more early-stage private investment.

 

  • Shares of common stock issued to founders and key employees of early-stage companies should be exempt from capital gains taxation – to reward entrepreneurs for their risk-taking and create the currency (stock options) that would encourage entrepreneurial activity.

 

  • Investors that contribute the first $5 million of equity financing to any new company should get a dollar-for-dollar tax deduction for the year the investment was made – that critical first $5 million is the hardest for any new company to raise. Risk-taking, venture-enabling job-creators should be encouraged and rewarded at the point of investment as opposed to a tax break many years down the road if the company monetizes.

 

  • Assuming appropriate disclosure of all of the risks entailed, any investor regardless of their income should be eligible to invest in private ventures – yet our current  securities laws are about to become more restrictive as a result of former Senator Chris Dodd’s discriminatory deal. The asymmetric investment return opportunities of private venture investment and these preferential tax incentives should not be available exclusively to “accredited investors”.

 

And finally, it is time for both parties to refrain from further legislative lipservice. For these policies to be effective in stimulating sustainable job creation they need to be enacted permanently so that entrepreneurship is embraced by the best and the brightest and that private investment and risk-taking is rewarded without threat of uncertainty or reversal.

 

Album:   Lipservice, Gotthard, 2005

2 Responses to “Lipservice (Bipartisan Pro-Growth Tax Policy Demagoguery)”

  1. VenturePopulist says:

    Readers–which of these specific proposals resonate with you?

  2. Steve Baker says:

    Jeff: Thanks for sharing your great ideas. You smack this issue right between the eyes! Your tax reform initiatives would help new business get up and running and start creating jobs. Here in Colorado, we have started a grassroots task force comprised of small business owners with the goal of reforming economic development within our state. (www.CIOcolorado.com) We are detailing the top ten needs of business and presenting them to our new governor and legislature prior to them convening in January. Small business must take a proactive approach to creating federal and state government programs such as your reforms that help us.
    I suggest that business in every state could benefit with our approach.

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