Proposition 30: Yet another way California screws entrepreneurs over
The Bay Area may have just signed its own death warrant with the passage of Proposition 30, one of the most shameful and despicable acts of legislation in American history.
Let me preface the article to come by pointing out that I am not some stodgy Republican or "Gospel of Wealth" libertarian who thinks himself holier than thou. I voted for Obama, because I support an increase in federal taxes along with a bunch of loophole closures. But don't think for a minute that Proposition 30 is even a distant cousin of the reasonable tax increases that we fortunate Americans are likely to face next year.
Proposition 30 represents nothing less than an act of inter-generational extortion. It is aimed squarely at young people and entrepreneurs, and it will damage the Bay Area’s slipping grip on technology leadership. To fully understand why this tax is unacceptable, one has to view California from a multi-decade lens.
Back in 1978, our parents’ generation, the Baby Boomers, passed a law called Proposition 13, which put a permanent cap on their property taxes. The cap was so rigid that it basically cut off the state's primary source of revenue. States like Florida, which don't have such laws in place, are able to charge zero state income tax as a result of their property tax intake.
The law was fortuitous for the Baby Boomers, as it was soon followed by a wave of inflation and massive house price surges, to which they enjoyed only financial upside. What has happened since then is three decades of financial strain on California, with countless victims, including our schools. These perpetual financial woes exist despite extremely high income and sales taxes.
But now the situation has become so untenable, that the voters of California have decided to hike income taxes to levels that are unprecedented anywhere in the nation.
Not only that, but they have decided to intentionally target entrepreneurs who have sold their shares in companies like Facebook, Yelp, LinkedIn, Yammer and every other company that has enjoyed high capital gains after years of hard work. In order to ensure that Facebook, and other big-ticket winners get targeted, they made the taxes retroactive to include 2012 -- yes, they are retroactively taking away money that has already been earned.
So let's review…
The Baby Boomers bought homes when they were our age, then decided that they were entitled to a life without property taxes. Then their homes appreciated by about 2,000 percent in value. Then, after mismanaging the states finances to an almost criminal degree and driving our schools into the ground, they decide that their successful children can take care of the problem. They retire and jack up our income taxes now that they aren't working anymore.
This isn't a tax increase. This is an act of inter-generational theft. So, what is the impact of it all?
Conventional wisdom states that income taxes rarely force people to move or renounce state/national affiliations. There will be no Eduardo Saverin syndrome here in California. But the bureaucrats and geriatrics -- Governor Brown is both of those things -- have failed to consider a few points.
First, it is a lot easier to start companies outside of California now than it was 10 years ago. It's not just because we can FaceTime our employees. Nor is it because cities like Austin and Seattle, where there is no income tax and rents are half the price, are improving their tech chops. It's because the barriers to start a business are so low. Companies like Dropbox can be started in short order, and with very few people. This isn't 1998. You don't need an army of engineers and $10 million in venture financing to get an idea off the ground.
Second, this law will really piss off second-time entrepreneurs. And they're the ones who matter most. People who have already succeeded are flush with capital, able to raise more capital with ease, and have extensive networks in place. There's no reason they can't start their company out of state, and simply open a satellite office in San Francisco.
The impact of the tax cannot be understated. It equates to approximately one full round of venture dilution. Remember that the 13 percent income tax comes out of the 76 percent that federal does not touch. This means that roughly one-sixth of your final after-tax take is now gobbled up by California. About the same as a round of venture dilution. And if there is one thing that second-time entrepreneurs love, it’s avoiding the dilution traps that they succumbed to in their earlier ventures.
By living in a city like Austin or Seattle -- where your employees pay less rent -- you can also extend the runway of your company, since people can live comfortably with a salary under $100,000.
Third, California has misjudged its citizens, and greatly miscalculated their allegiance to the state.
Politicians will argue that our schools, especially the universities, are a backbone of the ecosystem that empowers Silicon Valley. But that's just not as true as it used to be. Many of the top entrepreneurs in the state -- Mark Zuckerberg, Drew Houston, and Kevin Systrom, to name a few -- are East Coasters who moved out here. And, especially in the case of Facebook, a lot of the early employees were graduates of Harvard and other Ivy League schools.
Each of these people will have their own opinion of Proposition 30 and their allegiance to California, but we can imagine that they also enjoyed their education and upbringing in New York or Massachusetts, and probably would not mind raising their children in a state with functional schools.
They will likely recognize that Silicon Valley is becoming a culture more so than a location, and that this culture is beginning to root in a lot of other places. Some will take the Tony Hsieh route, and try to bring the Silicon Valley vibe to a new place like Las Vegas (where they don't have income tax). Others will simply "move back home" once they've made their millions, and start the next company out of their home office in Boston.
Again, an oppressive state income tax will not be enough to drive some people out. But it is naive to think that the thousands of young millionaires who are about to get hit by this retroactive tax will not think twice about it when they talk to their financial planners.
In the end, nobody knows for certain how this tax will impact individual decisions. These types of things are incredibly anecdotal in terms of the evidence on either side. Politicians will provide figures to suggest that income tax does not cause exodus, but these taxes are unprecedented, and coming at a time when people are less rooted to California than ever before.
So, in truth, our governor has no freaking clue what the impact will be. But it's going to leave thousands of future "job creators" with an awfully bad taste in their mouths.
[Image courtesy 401(K) 2012]