A Tax Hike That Scares Away the Technorati? Fat Chance

Earlier this week, tech entrepreneur Ethan Anderson compared a recently passed, temporary tax measure, Proposition 30, to expropriation and suggested it could “dampen enthusiasm for starting new business in California specifically.”

Anderson is right about many of the odious aspects of the measure, which raises the personal income tax for high-earning individuals for seven years. If an individual makes at least $250,000, he or she is now paying an additional 1 percent in taxes to California; anyone making $300,000 a year will have to fork over an additional 2 percent; and those making at least $500,000 have just seen their personal income taxes increased by 3 percent. (Overall, the increases are expected to impact the top 3 percent of California’s income earners.)

Proposition 30 could be particularly harsh for entrepreneurs, who, if they’re lucky, often receive long-awaited but sizable payouts for their efforts. “Someone who makes $250,000 for five years in a row will not get a tax increase, but someone who made little income for four years and then $1 million in the 5th year will get hit” with $30,000 in extra taxes, notes serial entrepreneur Jonathan Abrams, whose newest startup, the social news reader Nuzzel, is based in San Francisco.

The fact that the proposition has a retroactive element has also raised the hackles of the startup community. Abrams, who voted to pass the measure, says he “didn’t realize” it would increase taxes dating back to January 2012 and that he feels a “bit misled.” He calls it “unfair” and a “bad precedent.” (Spokesman H.D. Palmer of California’s Department of Finance says that “regarding other cases of retroactivity,” there is at least one precedent; when the fiscal year 2009-2010 budget was signed and a two-year, 0.25 percent income tax surcharge dating back to January of 2009 was implemented.)

Scott Banister, a prolific angel investor who cofounded IronPort Systems (acquired for $830 million) is even more direct, calling Proposition 30′s retroactivity “disgusting.”

“[T]axes on income from wages or stock sales in January were already paid via withholding or estimated tax payments,” he wrote in an email yesterday. “People then took what they had left and did something with that money – spent it, invested it, etc. It can’t be unspent, and if invested in something illiquid can’t be un-invested either. The whole prospect is scary, and if you didn’t already live here, would you want to subject yourself to the possibility of retroactive taxes by moving here?”

If I were an entrepreneur? Definitely.

In a newly released study, UCLA economist Jerry Nickelsburg calls Proposition 30 a “double-edged sword” because it relies too heavily on the state’s wealthiest residents and doesn’t solve the problem of how California supports itself longer term.

But the proposition will also generate at least $6 billion in revenue between now and 2019, money that’s being spent strictly on education and should make California an even more attractive place for entrepreneurs. After all, by bolstering California’s schools, Proposition 30 will inevitably spawn a more educated workforce.

The process won’t happen overnight, of course, but it’s certainly a start in the right direction for a state that lags behind other states in funding and staffing levels. What’s more, California’s investment in education is also an attractive lure for startup employees who want to provide great schooling for their children.

As for Proposition 30 being the tipping point that will cause entrepreneurs to set up shop in Nevada or Wyoming, I highly doubt it. Rich Californians have paid high rates for a long time; they contribute 22 percent of the state’s tax revenue. (In fact, as our Reuters’ colleagues reported last month, a study out of the Stanford Center on Poverty and Inequality has found that more millionaires came into California after the state added 1 percent of tax to incomes over $1 million in 2005.) An extra 1 percent to 3 percent in tax  will hardly outweigh the dramatic upside of starting a company in the state now.

The bottom line is that people start and invest in companies in California because they’re risk takers. They swing for the fences. They’re looking for big wins that they could never achieve anywhere else.

Entrepreneurs like Banister and Abrams are in it to win it.

“I’m not going to leave California because of Proposition 30 or somewhat higher taxes,” says Abrams. “If I really wanted to avoid high state taxes, I wouldn’t be living in California in the first place.”

Photo: California Governor Jerry Brown speaks alongside his wife Anne Gust Brown at a private reception in Los Angeles July 8, 2011. REUTERS/Matt Baron/Pool

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  • It is a truly bad precedent to be placing these retroactive taxes on the segment of the population that is creating jobs. Despite the advantages of the tech community, entrepreneurs should consider establishing their startups in other states. Technology talent is incredibly expensive and the need to be local has been reduced (outside of angel investors).

    I started a discussion about whether entrepreneurs should remain in California: http://www.the-counterpoint.com/discussion/20

  • Although Brown and his union cronies sold this tax increase as a way to fund California’s struggling schools the law does not have any requirement that the money actually be spent on education but rather the money becomes part of the general fund. Call me a cynic but based on past experience, with no legal requirement or audit mechanism I have little confidence I have little confidence this money will actually reach its intended purpose nor achieve the positive results to which you allude.

  • A quick glance at history quickly disproves the notion that putting more money into education spending will “inevitably” result in a better educated workforce. Look at the past few decades in the U.S. – big increases in education spending (including when looking at spending on an inflation-adjusted, per pupil basis) and little if any correlation between spending increases and improved educational outcomes.

  • The three of you could well be right about how the money is spent (though I hope not). My broader point was that there aren’t startup resources to match those in Silicon Valley, so as mad as the tax may understandably make the entrepreneurs and investors who live here, they probably aren’t going anywhere.
    As Howard Anderson –founder of Yankee Group, cofounder of Battery Ventures, and now M.I.T. faculty member — told me earlier this week: “If taxes rise, do you move to Costa Rica? Hell no. You want to be either close to your talent pool or close to your customers. Taxes should be about the 15th concern on your list.”

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