California under Jerry Brown and a near supermajority Democratic legislature has been doing something right. The state has managed to marry high job growth with a good helping of progressive policies: serious investment in social services, education and infrastructure, and the will to make higher income earners pay up.
The state even runs a surplus to take care of any nasty surprises.
This didn’t happen by accident, and while enlightened public policy played a role in clawing the Golden State out of the great recession, the private sector played an important role as well. Just as the state has been progressively investing in things that are important to the people’s future, so have venture capital and other private equity firms.
That’s how many of the start-ups in and around Silicon Valley get funded and eventually take off, generating good-paying jobs for hundreds of thousands of people, at a minimum. Venture capital is a vital part of California’s future economic progress — the financial engine that keeps so many computers running.
So, it is concerning to see otherwise progressive members of the state legislature in Sacramento, including Assembly member Mike A. Gipson, introducing legislation that threatens to halt our technological progress in its tracks. The thing they’re addressing is the so-called “carried interest loophole.”
Now, the issue is complicated. The simple version has to do with how managers of venture capital funds and similar businesses should be taxed on their compensation. Since this is investment income, they tend to be taxed at capital gains rates, which are lower than income tax rates. Some think this is unfair. The more complicated form of the argument looks at how the compensation isn’t structured like income and the economic effects of treating it as income.
It seems to me that, by closing this “loophole,” we might be sending the wrong message to the financial world. They could read it as, roughly, “We don’t want you here. Try other states.” And that is a disastrous message to be sending.
Right now, we are happy that so much capital gets invested in the breakout companies of tomorrow that are based in California. There’s a reason that so many tech firms are located in the state, which no longer has much to do with easy access to silicon. There is a mini financial industry that is willing to back many of the potential successes of the future and write off substantial losses when some of those companies don’t work out.
Such investments involve serious risks, both to the people who put their own money at risk and to managers, who, by and large, don’t get paid if enough of their bets don’t pay off. There’s no reason that industry has to stay within California’s borders. In fact, if we say through legislation that we don’t want it in the state, there’s a good chance that many VC firms would go and fund companies elsewhere.
That would be a shame. California is a great progressive success story and venture capital is a significant part of that success. Let’s sideline this ill-considered legislation and keep things running.
