California Legislature Shouldn’t Tax Innovation

TaxesWhen it comes to innovation and job creation, let’s keep the gold in the Golden State.

The role of private equity in funding the growth of many bread-and-butter, consumer-based firms that call California home – companies such as Peet’s Coffee and El Pollo Loco – is in serious jeopardy due to the possible re-emergence of faulty legislation in 2019.

Last year in the Legislature there was a proposal (Assembly Bill 2731), borne of understandable but misguided frustration over federal tax policy, that would have pushed the private funds financial services industry to other states. Fortunately, that proposal did not advance. Lest California lawmakers think again about cutting off an economic engine in a self-destructive over-reaction, the idea should be permanently shelved.

California is the earth’s epicenter for innovation, attracting entrepreneurs and talent from across our state and around the globe.  It’s blessed with world-class universities, robust markets, and it’s been a pace-setter in emerging industries. All of this is made possible by one essential element – access to capital.

Data from 2016 shows that the Bay Area is the number one market in the nation for venture capital, generating an impressive $23 billion in investment; more than three times that of New York sitting at number two.

A proposal like AB 2731 would put a chokehold on venture capital in the state by creating a 17 percent add-on income tax on the private funds financial services industry. The tax would apply to so-called “carried interest income” earnings – but interestingly enough only in the financial services sector, not in other sectors such as real estate, oil and gas development in which such earnings are also common.

An economic impact analysis of the proposal conducted by a professor at USC’s Marshall School of Business understandably concluded that the tax would be “so impactful that the industry will likely move out of state.”

The consequences of such a flight from California would be devastating. The industry directly employs more than 100,000 workers and pays a combined $2 billion a year in state and local taxes.

The American Investment Council estimates that private equity companies invested $66 billion in 583 California companies in 2017 alone. Those companies combined provided more than 400,000 jobs. In addition, an estimated 5,200 California-based companies now with more than 250,000 workers relied on venture capital funding to get off the ground.

To push back against federal tax policy by even considering a large, state-only tax increase on an industry that fuels economic growth and job production is destructive folly. Jobs would be lost, economic growth would be diminished and there would be a net loss in state and local tax revenue as a result of industry flight from California.  This proposal failed last year, and should not be reconsidered this year.  There is never a good time for a bad idea.

resident & CEO, Silicon Valley Leadership Group

This column previously appeared in the Sacramento Bee