May 19 2010

Am I just a greedy VC?

My partner Jason has an impassioned post up about the carried interest debate currently taking place in Congress. No matter how you feel about Congress’ efforts to change the tax classification of VC profits from capital gains to ordinary income it’s worth a read (and keeping an open mind).

Obviously this issue is important to me and to all VCs. And while I know there are differences of opinions on the subject (clearly given the intense debate going on right now) I think Jason does a nice job of talking through the personal (this feels overstepping), professional (there are other markets where innovation is taking place where investor are actually being completely exempt from taxes that will draw talent away from the US) and legal (how do you differentiate between a VCs partnership interest from other partnership interests not subject to the proposed tax change?) arguments against the tripling of tax on the long term profits of investors.

While I wouldn’t say that I’m a “fan” of government, I’ve always been of the mind that some level of government safety-net is appropriate. I’m even, generally speaking, ok with a progressive income tax and as a relatively high wage earner understand that I have a certain burden living in our society to pay a much greater share of the overall tax burden. I point this out not to get into a political debate about the benefits of taxes, the proper level of tax  or even the correct taxing system but to be clear that my views on carried interest are not part of some larger agenda around reforming the tax system or eliminating it all together.

I have many of the same concerns that Jason outlines in his blog post about the move to change the tax treatment on carried interest. I’ve even considered whether the change will either shorten or radically change my own career path.

But as a capitalist and a realist I’d simply point out that taxes shape behavior. Our tax code has examples of this everywhere. Want people to buy houses? Allow them to write off their home mortgage (but don’t let them write off credit card debt – we don’t want consumers to have too much of that…). Want people to give to charity? All them to write that off too. Want to encourage longer-term investing? Tax that at a lower rate than short term investing. Need to encourage people to save for retirement? That’s a good one for tax exemption. Invest in education? Check on that one two.

My point is that tax code changes have real world economic and behavioral consequences. And the consequence of tripling the tax on the carried interest of investors will be decreased investment, less innovation and fewer jobs (and I would guess an overall reduction in tax receipts given the 2nd and 3rd order effects of the measure – which completely defeats the purpose of the proposal which is 100% to raise revenue and “fund” the extension of other tax initiatives).

The US currently leads the world in the innovation economy. From our universities, to our entrepreneurial ecosystem, from the belief that it’s ok to step out and try, even if you fail, to our system for nurturing and funding companies, we have a huge global competitive advantage in innovation that has lead to some of the greatest advances in modern society coming from within the US. Venture Capitalists have been an important part of this trend (companies that are or were once VC backed account for 11% of the US workforce and over 20 of US GDP).

The sky is not falling and the day after the tax code is changed (if we’re not successful in convincing lawmakers what a bad idea this is), little will be different in my job or in the jobs of most investors (although no doubt the lawyers will be hard at work figuring out new investment structures). But there is no doubt in my mind that this massive alteration in how we tax the work of a group of people who nurture and fund innovation in the US will radically change the long term trajectory of the our country’s innovation economy. With the focus on job growth and job creation and with countries like China and India knocking at our door trying to be the growth engines for the next millennium’s global economy, is now the time to put shackles around the building blocks of what’s allowed the US to lead the world in technological innovation? I, for one, surely don’t think so.