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Obama Tax Plan a Frontal Assault on Entrepreneurs

The people Obama wants to tax are the very people whose wealth drives innovation.

by
Jeffrey Carter

Bio

September 25, 2008 - 12:10 am

In the Democratic acceptance speech, we heard a lot of anachronisms.  The ones I would like to focus on are statements on taxes and medicine.  Senator Barack Obama has said that he will raise taxes on anyone who makes over $250,000 per year.  He also said he would eliminate capital gains taxes on small business and start-ups.  He favors a socialized medical establishment rather than an entrepreneurial market-based one.  These statements are at odds with each other.

In the global economy, it is imperative that we foster innovation and entrepreneurs so we stay far ahead of the curve.  These are the types of people and businesses that will grow to become economic drivers in the new economy.  Our tax policy today does not do enough to encourage risk-taking and entrepreneurship.  Obama’s tax plan shoots a howitzer and potentially blows up a $26-billion industry.

Apple, Microsoft, Sun, Cisco, and many others were nascent businesses in the 1980s. They came about because of technological revolutions and were fostered by risk-taking angels and venture capitalists that had incentives due to the Reagan revolution. We had an evolution that created whole communities like Silicon Valley.  In order to prosper in the global economy, we need to continue to create these kinds of communities.

Why can’t it happen under an Obama tax plan?  Isn’t profit enough of an incentive?

The problem with that assumption is that you are not accounting for the amount of risk one takes when they make an angel or venture investment.  When you factor in risk, tax liability, and capital costs, a much greater return on investment is required.  A higher bar means there will be fewer investments, meaning less innovation.  At early stages it’s exceedingly difficult to pick winners and losers.  An angel investor is considered successful if they have a profitable exit three out of every ten investments. Obama’s tax plan will restrict the amount of potential money available for investment and will limit the amount of investments made because of the increased rate of return needed to cash in.

But what about low/no capital gains on investments?  In today’s tax code, there already is a provision that allows the investor to roll over from one investment to another tax-free or tax-diminished.  Obama is proposing nothing earth-shattering here.

Who are these angel investors?  They are the people that Obama considers wealthy.  The federal government’s tax code has rules about who can be an angel investor. Not only do accredited investors have to pass an income test, but they have to pass a wealth test too.  The angel investor is precisely the person that Obama targets through his tax plan.  His “soak the rich” philosophy will drain them of some of the risk capital they would normally use to make investments in new technology and ventures that could strengthen the American economy.  This is not trickle-down economics; it’s a business fact.

The new venture has a predictable path when it comes to funding.  First, a person has an idea.  He spends a little money on it.  Eventually, he goes to friends and family.  Once that money is used up, he goes to angels.  At the angel level, investments run from as low as $100,000 all the way up to $3,000,000.  Venture capital firms do not get interested in companies until they get to at least $5,000,000 in valuation. The company must have some economy of scale and track record before the venture community takes risk. Capital gains taxes only come into play when there is an exit or you are able to take money out of the firm.  Obama’s tax plan puts the cart before the horse.

Secondly, health insurance has hamstrung the entrepreneur.  Currently, it is very expensive for entrepreneurs to get insurance because they can’t take advantage of large corporate plans.  Many businesses are underinsured or not insured at all.  Angel investors want the entrepreneur to get insurance because it protects their investment.  Insurance adds to the cost and raises the amount of return needed to invest.  Obama and the Democrats’ answer to this problem is socialized medical care.  This has been a disaster in Canada and virtually any other large diverse country it has been tried in.  Only the Scandinavian countries have had any success with socialized medical care.  What should we do?

The one thing that we can’t do is waltz down the path we are currently on.

Health care costs encumber entrepreneurs because they make it expensive to hire needed employees. The way out is to make the market more competitive and to use tax policy to encourage people to get insurance.  Current market conditions are anti-competitive.  Insurance companies have virtual in-state monopolies.  We need to end border-related restrictions on insurance.  Secondly, we need to untie insurance from your job.  Instead, we need to make health insurance premiums tax-deductible for everyone.  If you are indigent or below a certain income level, the government should issue vouchers to you for basic coverage and catastrophic coverage.  This will cause virtually everyone in the U.S. to be covered.  It will be far cheaper than the Obama socialized medical program.  Competition will cause insurance companies to drop price and increase service.  Innovation will come to insurance and new and different types of policies will enter the market, making it even more competitive.  Consumer behavior will cause people to shop for insurance and minimize costs while trying to increase coverage.  Once we embrace the free market, we can take on doctors — and the attorneys that sue them!

Jeffrey Carter is a former member of the Board of Directors of the Chicago Mercantile Exchange, and has been a “speculator” — independent trader — since 1988. He holds an MBA from the University of Chicago and blogs at www.pointsandfigures.com.
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