A Tax Reform Agenda for the Entrepreneurial Ecosystem

Tax policy is one of the most powerful economic levers that policymakers have at their disposal. So it is concerning to see that instead of modernizing the tax code to recognize and support entrepreneurship, tax policy discussions in Washington have been more likely to focus on increasing taxes on the entrepreneurial ecosystem. For example, there have been calls to increase taxes on carried interest capital gains and repeal the Qualified Small Business Stock (QSBS) rules to pay for unrelated priorities.

At NVCA, we think this is the exact wrong way to view tax reform. Instead, tax reform should be an opportunity to support the creation and growth of more U.S. companies. We have submitted a policy paper to the U.S. Senate Committee on Finance detailing a tax reform agenda that would encourage new company formation. In this submission, we explain why startups are so critical to the country’s economic competitiveness, why startups are a unique business model, and call for a specific section in tax reform that should be devoted to proposals that would encourage new company formation. We then detail four tax reform proposals that would help startups without creating a new credit or deduction. These ideas include:

  • Allow more startups to access the benefits of the R&D credit.
  • Make the QSBS rules easier to use, and expand the eligibility limits.
  • Provide startups a safe harbor from Section 382 Net Operating Loss (NOL) limitation rules, which can arbitrarily punish startups for hiring and investing in innovation.
  • Allow employees at startups to defer paying taxes on certain stock options.

In this submission, we also detail how the capital gains rate differential and carried interest capital gains are fundamental to the economic climate for risk-taking and patient capital investment. We explicitly warn policymakers that increasing taxes on entrepreneurial investment and activity would be a terrible miscalculation at a time when we find ourselves in a global competition to build the next generation of companies. Further, we explain that these policies are important for not just our national competitiveness, but are absolutely critical if we want to see the growth of new startup communities around the country.

At times we hear “well startups don’t pay any taxes, so why should they care about tax reform?” The unfortunate reality is that policymakers and experts too rarely focus on entrepreneurship as an issue in tax policy, and there are numerous examples of the consequences of this oversight. The R&D credit does not benefit many startups despite the disproportionate amount of R&D investment undertaken by these companies. NOL limitation rules can convict startups of tax gaming for little more reason than the fact that they are not profitable yet. When Enron went bust, startups shared in the punishment when Congress created the 409(A) regime as a response. And now we face one of our greatest challenges yet in the debate over carried interest capital gains, a tax increase proposal that’s most often characterized as going after hedge funds but would have the most severe impact on the venture capital industry.

Our goal is to change this dynamic by laying out a positive pro-entrepreneurship tax agenda. We hope this paper will foster a more constructive dialogue where issues important to the ecosystem can get their fair hearing in tax policy debates. We have a long way to go, but with strong coordination among our members and allies, we have a real chance to make new company formation the priority it should be in tax policy.

Make no mistake, there are some real champions fighting for startups in tax reform out there today. Standup leaders such as Senator Mark Warner (D-VA) and Congressman Erik Paulsen (R-MN), who questioned Treasury Secretary Mnuchin recently on this issue, have been fighting for these very priorities since before I came to NVCA. We will continue to support them and their allies, and work to attract more policymakers to their side.

That’s a quick summary of our startup tax policy agenda. Please take a look at our submission and let me know your thoughts (jfield@nvca.org). We look forward to working with all of you to educate policymakers on the need for tax policy that encourages new company formation.