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A bill just passed by the House discourages venture capitalists just when they're needed, argues Ted Schlein
Now that we seem to have hit the bottom of the so-called Great Recession, talk of additional stimulus aimed at avoiding a "jobless recovery" has begun to stir in Congress and at the White House. Last week President Barack Obama proposed measures to "accelerate job growth" and "get businesses hiring again." Unfortunately the House of Representatives is moving in the opposite direction. On Dec. 9 a majority of U.S. House members voted to hobble one of America's most prolific and reliable job creation and innovation engines by passing a bill—HR 4213, or the Tax Extenders Act of 2009—which would eliminate the capital gains tax status for venture capital carried interest. This change would effectively double the tax burden on venture capitalists when they build successful businesses. In order to pay for yearend tax extenders, such as the corporate research and development tax credit, the House is eliminating the capital gains tax status for carried interest, a return venture capitalists earn when their companies go public or are sold. Carried interest is the economic incentive that encourages long-term venture investment in small businesses. For decades it has qualified for capital gains tax status because it works. Venture Capital's Value
The long-term economic impact of venture capital investment is significant. Today, companies that have benefited from venture capital investments since 1970 employ more than 12 million people and generate revenue equal to 21% of U.S. gross domestic product. From 2006 to 2008, employment at these companies grew 1.6%, eight times the rate of job growth in the private sector as a whole. And these are just the employment numbers; they don't take into account the value of countless lives saved and improved thanks to the medical, technological, and environmental innovations created by these companies. Doubling taxes on venture capitalists who build these companies is not only discouraging but could catalyze a major decline in the already shrinking U.S. venture market. While venture capital has persevered during the past year, our community is hardly immune to the current economic crisis. Thus far in 2009, venture investments as measured in total dollars have fallen 45%, while the number of venture capital firms in the U.S. continues to decline steadily. The average age of a venture-backed company going public has increased to 10.5 years, from 5.45 years in 1999. The motivation to invest is becoming increasingly difficult to find. Yet despite these challenges, the venture industry has continued to do what we do best: create jobs. According to the online job board StartUpHire.com, venture-backed startup companies have filled more than 24,000 jobs in 2009, adding an estimated 3,000 new jobs each month. While the national unemployment rate sits at 10%, venture-backed companies are actively trying to fill more than 11,000 open positions. Crucial jobs, crucial industries
Perhaps more importantly, these jobs are in industries critical to U.S. economic and innovative leadership and central to some of our most pressing national issues: information technology, life sciences, and clean technology. When politicians say they expect future innovations to reduce health-care costs, or help confront climate change, they're counting on these very companies to deliver. Yet ironically, by taxing venture returns as ordinary income and not as long-term capital gains, Congress is removing a major incentive to invest in innovative young companies. In effect, the risks will remain the same, while the rewards plunge. This is no fair shake for an industry that has created millions of jobs and paved the way for American prosperity for nearly four decades. It won't look attractive to venture capitalists, either. Left without incentives, VCs will look for ways to manage their risks by taking shorter-term positions in up-and-coming companies. They'll also be more likely to favor investments in later-stage businesses. Fewer seed-stage and early-stage companies will be funded, leading to fewer new jobs created, and the pace of important technological innovation will slow. Over time, fewer bright minds will choose venture capital as a career, because the diminished rewards will no longer justify the risk. Missing the Mark
These are serious and permanent ramifications for a bill whose purpose is to pay hastily for tax extensions that last for only one year. Congress may be helping big business, but it is on the backs of investors in small businesses. This policy is counterproductive to economic recovery. For these reasons, the Senate should stop HR 4213 in its tracks and put forth legislation that recognizes the value and impact of venture capital and the young companies and industries it nurtures and the jobs created as a result. We all know that when you raise taxes on a certain behavior, you discourage it. It seems our country needs to encourage more innovation, more jobs, and more competitiveness right now, not less. Earlier this year, the Obama Administration and Congress tried to put America back on the road to recovery by passing aggressive economic stimulus packages. There recently have been positive signals that the economy is starting to recover. We may be on the road to a better economic future, but the Tax Extenders Act of 2009 is nothing short of a wrong turn.