Tax Capital, Block Immigration, Kill Competitiveness

What does it take to ruin an economy?

Destroying an agrarian economy is just a matter of killing the people and salting the earth. After the industrial revolution, nations based their economies on factories, transportation and labor. If you wanted to ruin an industrial country’s economy, you bombed the factories, sank the ships, derailed the trains and killed the laborers.

But destroying a post-industrial economy is much easier, as our legislators will soon learn. Capitol Hill is starving the U.S. of the two greatest factors of production it needs: money and brains.

Money

The pains of Sarbanes-Oxley are well documented and should be familiar to readers of PEHub.com. Many professionals say this legislation has driven investor dollars into foreign companies, U.S. companies to foreign exchanges and helped bolster an unprecedented private equity boom.

But now, private equity has come under fire from legislators aghast at “unseemly” compensation extravagance. Democrats have proposed a plan to tax carry as income rather than as a capital gain.

The move would whack VCs in their wallets at tax time, but it might also do to private equity what Sarbanes-Oxley did to U.S. public markets. “One of America’s remaining competitive advantages in the world economy is capital allocation,” says Rob Chandra, a managing partner at Bessemer Venture Partners. “This bill, if passed, will be a great victory for other countries which will benefit from more of the capital allocation industry moving to their country because of lower taxes.”

Risk capital is a good thing for the economy, argues Steve Harrick, a general partner at Institutional Venture Partners. He cites the National Venture Capital Association’s “Venture Impact” report, which says that some venture-backed companies accounted for some 10 million U.S. jobs in 2005. Upping the taxes private equity practitioners face would be “…disastrous for employment and opportunity in this country,” he says.

It’s an argument echoed again and again by private equity professionals: Everyone is better off when investors invest. The proposed bill would prevent money from greasing the wheels of progress.

The governments of agrarian economies weren’t so dumb as to give away their land, so why should our government give away the modern day equivalent? Capital isn’t tied to national borders. It flows to where it is welcome.

And it isn’t the only factor of production that U.S. legislators are ignoring.

Brains

Brains are increasingly driving the U.S. economy. The service sector, that’s lawyers, bankers and doctors, comprises 80% of U.S. employment and 64% of U.S. GDP according to government data. We’ve been trending in this direction for years and will continue to do so. When was the last time a company looked smart opening a factory in the U.S.? The future lies in enterprises based on knowledge, know-how and innovation.

Getting the best brains in the world to the U.S. isn’t a problem. Foreign students earn 30% of the doctoral degrees awarded in the U.S., 8% of the undergraduates at Ivy League institutions are foreigners and 20% of newly hired professors in science and engineering are foreign-born, according to a recent article in Newsweek. The problem is keeping them.

Former Intel CEO Andy Grove famously said we should staple green cards to the diplomas of every foreign national that earned an engineering degree in the U.S. The Hungarian born entrepreneur and executive knew the value brains would play in developing new businesses and encouraged welcoming them with open arms.

But legislators—influenced by a hodge-podge of jingoist rhetoric, misguided protectionist policies and fears of terrorism—have been slow to ratify the most basic policy provisions aimed at opening the U.S. to those most able to contribute to its wealth.

Changes to the H-1B visa program are mired in a 628 page immigration bill that has become a referendum on illegal immigration rather than a progressive policy discussion on sustaining economic growth. The basic quota for skilled workers could rise 77% to 115,000 per year if the bill passes, but even that may not be enough. There are choke points further down the line when temporary workers apply for green cards and find that they’re in a back-log that can last up to 12 years, according to a recent article in the San Francisco Chronicle.

The Solution

The U.S. needs to overcome its fears. Legislators responded to the fear of corporate malfeasance with Sarbanes-Oxley, fear of the wealth created by private equity professionals with higher taxes and fear that foreigners would steal U.S. jobs or become terrorists with immigration restrictions.

The path forward is defined by optimism, not fear. Progress is the product of bravery.