Considering the Implications of Tax Reform on the Entrepreneurial Ecosystem

Like clockwork, with each new Congress comes a renewed push to embark on a wholesale rewrite of our nation’s tax code. Sure enough, the start of the 114th Congress is proving no different. Not only did President Obama touch on his priorities for tax reform in his State of the Union address last night, but the Senate Finance Committee recently announced the formation of five bipartisan working groups to develop concepts for a tax reform proposal. All of this comes after Rep. Paul Ryan (R-WI), the newly minted Chairman of the House Ways and Means Committee, announced his own intentions to proceed with a separate tax reform proposal in the House after he took over the gavel of the chamber’s tax-writing committee.

As these discussions take flight, there is both a challenge as well as an opportunity for everyone that has a stake in the health and vitality of the entrepreneurial ecosystem to convey to policymakers that even the slightest changes to the tax code can have a disproportionate impact on the creation and growth of new startups in America.  All too often the implications of tax reform on the entrepreneurial ecosystem are overlooked during tax reform debates simply because startups claim a small percentage of the American economy despite being responsible for a large percentage of its growth. In fact, many of the companies that now dominate the Fortune 500 have roots as young venture-backed startups. Companies as diverse as Microsoft, FedEx, Intel and Starbucks, to name a few, were all cultivated in the entrepreneurial ecosystem on their way to becoming the successful companies they are today.

In the 21st century economy, the pace of startup creation will increasingly play an outsized role in the rate of our economic growth and global competitiveness. That’s why we believe policymakers must consider how tax reform can increase the development of new startup companies as well as provide the best opportunities for existing startup companies to flourish and grow.  To that end, any tax reform proposal must first consider how current tax policy affects the American entrepreneurial ecosystem before determining what needs to be preserved and what needs to be modified.

Building a startup from the ground up to become a successful company is a risky endeavor and ties up capital for long periods of time.  If changes are made to the tax code that reduce the reward for patient capital investment and entrepreneurial risk, then logically our economy will have less of that behavior. For example, a differential between the capital gains rate and the top ordinary income rate has been a positive and powerful force in encouraging entrepreneurs to take risks and chase their dreams. The decision to leave a steady job to found a company with uncertain prospects is incredibly difficult, yet the reward to the greater economy is enormous.

Investments in startups and small businesses are risky and even the most successful ones can take a decade or more to pay off. The venture community provides resources to these companies before they even come close to showing a profit, or even before they’ve had a single sale. These investments are the lifeblood of entrepreneurship, providing companies the ability to hire talented workers and focus on product development without the initial demand of having to turn a profit.

Making the decision to build and invest in startups more difficult by increasing taxes on entrepreneurs and their investors will have a stifling effect on entrepreneurial activity. That’s why we strongly believe that tax reform must protect appropriate rewards for entrepreneurial risk and long-term investment.

Support for growing the entrepreneurial ecosystem is broad and bipartisan, and we believe policymakers should view tax reform as a momentous opportunity to identify new ways to encourage increased entrepreneurial activity. There are a number of innovative modifications and improvements to the tax code that policymakers should consider to bolster the entrepreneurial ecosystem. For instance, certain tax rules which are arbitrarily restrictive for pre-revenue businesses should be reviewed with an eye towards reducing barriers to investment in startup companies. In addition, section 1202, which was written to encourage investment in promising small businesses, should also be reformed to make it more effective and easier to use.

These are just some of the ideas we hope policymakers will consider in the discussion around tax reform and we look forward to engaging with them on these ideas and others. The entrepreneurial ecosystem is a powerful force for economic growth, job creation and technological progress. We will remain vigilant in reminding lawmakers that the entrepreneurial ecosystem’s continued success is not guaranteed, but must be carefully cultivated and maintained in order to preserve it as an engine for growth for our country in the future.