Economy and Business Politics and Public Policy

The Biden Tax Plan and Unintended (Negative) Consequences

While I watched President Biden’s speech to both houses of congress last night I remained convinced that he is a good and decent man who truly wants to help the American people. I was also convinced that he is a product of Washington politics who has never done anything but be a politician. Therefore he does not understand the negative impact his policies will have on innovation and young start-up and private companies in general.

In addition to pursuing policies that will stifle innovation, he is using a lot of rhetoric to sell rather grandiose plans that he and his advisors may think are popular with some voters, but that in the long run will lead to more political division and strife within our fragile democracy. His administration does not seem to understand that what he proposes will not only harm innovation, but drive a great deal of cost into company operations that will stifle job growth. He clearly wants to help the “middle class” as he calls it, but he seems to have a 1950’s and 1960’s style outlook on how to provide that help.

Large scale government programs that will have to include private company involvement and much higher taxes may have worked in the 1960’s, but in a globally competitive world these ideas are no longer relevant. For example it is unclear how advocating union membership is going to help members of the middle class fit into a world of Artificial Intelligence, Machine Learning and Cryptography where advanced computer skills, not manufacturing assembly skills are the most important ones for citizens to obtain.

While helping people is a good goal, it seems like pushing such large plans through the legislative process in such a short time will lead to resistance that will drive the country farther apart. Given that a lot of the programs may not do much to aid the economy in its global modern form, pushing them through with a slim Democratic majority will also foster ill will. In describing the plans and what they are intended to address, the language used appears to vilify business and business leaders. The tone and rhetoric used to describe them, and the plans themselves seem quite harmful to not just the economy, but the state of political discourse overall.

In this post I want to explain how the tax plans President Biden proposes can stifle capital investment in start-ups, hurt small businesses of all kinds and lose jobs instead of “create millions of jobs” as he projected in last night’s speech.

Revenue Plans
Here are some of his plans that raise taxes to “pay for” some of the initiatives:

  • Raise the corporate income tax rate to 28%
  • Institute a “minimum corporate tax” of 15% on corporations over a certain size
  • Raise the top marginal tax rate to 39.6%
  • Raise the capital gains tax rate to be equal to the top earned income rate (plus the 3.8% Medicare surtax added due to the Affordable Care Act), placing the top rate for selling long term assets to 43.4%. Raising the capital gains rate to one higher than that paid on earned income

Problems with The Plans

-Raise the corporate income tax to 28%

The problem with raising the corporate tax rate is that under the Obama administration (when rates were 35%) we were seeing a number of corporate inversions where the headquarters of a company and a corresponding amount of investment was moving outside of the United States. After lowering the corporate tax rate to 21% in the 2017 tax reduction act this practice almost stopped. We have seen a boost in investment in the United States since the top corporate rates have been lowered and the talk of inversion is now non-existent.

We run the risk of losing investment in our own country by charging rates higher than they are now (21% nominal rate). Compared to countries in the EU that have educated workforces and a “business friendly” climate (like the Republic of Ireland) our top tax rate being higher would give corporations the incentive to move operations off shore again.

The argument Democrats make is that we “don’t want to precipitate a race to the bottom” (lowering corporate tax rates to levels of other countries like Ireland at 12.5%). However, CEO’s of public companies have to investigate the possibility of producing their technology and products in the most efficient manner possible. High tax countries will be less advantageous to certain companies than countries with lower tax rates where their products can be developed for those companies.

According to this source (tax the European OECD countries levy a 21.7% average corporate tax rate. Germany and France are at 29.9% and 28.4 percent respectively, with Portugal the highest in mainland Europe at 31.5%. So running our tax rate higher could precipitate a loss of investment to overseas locales. Far Peak Acquisition Corporation’s Tom Farley, past CEO of the NYSE, made the point that raising corporate rates is a very bad idea as capital is fungible. He mentions that it would be a breach of fiduciary duty to shareholders for a CEO of a public company to not pursue off-shore investment as an alternative to on-shore if the rates increase as proposed under the Biden plan.

-Institute a “minimum corporate tax” of 15% on corporations over a certain size.

This seems to be the “Amazon tax” because President Biden always uses Amazon Inc. as the “bad example” of the corporation “paying zero tax”. He states this in a way that implies they are cheating on their taxes (which they are not; they are following the law). The reason they don’t pay a lot of taxes is that they invest large amounts of their profits into capital equipment to grow their operations and make them more competitive. They build data centers, warehouses, distribution infrastructure, they buy trucks, planes and delivery vehicles. Amazon employs more and more people as a result of this investment. If the 15% of a huge ($54 billion) number is given to the government, then that is 15% not spent on expanding and hiring employees to work in Amazon facilities. I also am skeptical that the government will spend these funds as wisely as Amazon will.

Joe Lonsdale, co-founder of Palantier Inc. and founding partner of 8VC (venture capital firm) also has some interesting views on corporate tax hikes and their impact on start-ups and growing companies like Amazon who invest heavily to maintain growth and employment. Mr. Lonsdale states that rates are best left alone.

So my belief is that we should leave corporate income tax rates where they are and let the for-profit sector build as much infrastructure as they can to grow their businesses.

-Raise the top marginal tax rate to 39.6%

While I think that this is a generally bad idea, if this were the only thing done it may not be as damaging as the other parts of the plan. The next item where capital gains rates are raised beyond the rate of ordinary income is the problematic one.

-Raise the capital gains tax rate to be equal to the top earned income rate (plus the 3.8% Medicare surtax added due to the Affordable Care Act), placing the top rate for selling long term assets at 43.4%. This is a corporate tax rate higher than that charged on earned income

Unintended Consequences

Removes Incentives for Risk Taking

Having the capital gains rate to be higher than earned income undermines the entire venture investing model. It is common for founding members of venture backed start-ups to work literally for years for no or very little salary so that they can build their businesses into something valuable enough to invest in let alone sell for a capital gain. Then it can be years before they earn even a competitive salary that they would have had working at a job with Google, MicroSoft, etc.

My previous start-up was self-funded and I put all the money into the company from past investments I had made without ever taking any salary. For nearly three years I worked essentially “for free”, supporting five other families. My “payoff” occurred when I sold the business. The incentive was to make a good return on my investment. If I had to pay more (in taxes) than I would have had to pay if earning regular (W-2) income I would have been much worse off when I sold the business than I was at the end of the three years when I sold the business to Bloomberg LP. The capital gains rate being lower than the earned income rate enhances the incentive to take risk and innovate on behalf of the economy.

Mr. Lonsdale was again recently on CNBC squawk box explaining that he believes raising the capital gains rate removes incentive for people to leave jobs with large established Silicon Valley firms (Google, Facebook etc.) and take a chance on a start-up. Without a promise of a payoff beyond what one would get earning regular income, most would not choose to take the risk of a start-up and do something innovative. He recently moved his firm to Austin Texas because as he stated: “Silicon Valley is becoming filled with risk-averse individuals”.

He mentioned an example where a person making $3 million per year at Google would have little incentive to join a start-up and to help build something innovative if there were no favorable capital gains treatment. They would have more incentive to stay and earn regular income in such a case than to take a chance and help build a new company.

It takes a lot of courage, commitment and hard work to build a successful start-up and there is risk involved. Therefore, favorable tax treatment is a justifiable incentive to include in the tax code for companies seeking to innovate and build new products. Without this incentive, many jobs will never be created in new industries and the entire economy will suffer.

Makes Established Tech “Giants” even Larger and More Powerful

With less incentive to start companies, the large technology companies will get larger and more powerful. Now, even with a capital gains rate advantage, start-ups cannot compete with the salaries that Google, Apple, Facebook and others are able to offer employees. If this capital gains tax rate is hiked as President Biden proposes, then the technology companies will only get more powerful. Someone on Mr. Biden’s staff should go find Amy Klobuchar (Senator from Minnesota) and break the news to her that they are going to make her job even harder (she wants to break up Facebook, etc.). If Senator Klobuchar thinks Facebook is too big now, then she will be really surprised how powerful it gets when it does not have to compete with smaller, nimble start-ups.

Not Just Start-ups, but All Small Businesses are Affected

It also kills non-technical small businesses that have relied on “sweat equity” to build value into their businesses for years. When a small business owner decides to sell his or her entity they have often sacrificed salary and time with loved ones for years to make the business valuable. To have the sale of the assets taxed at a rate above the earned income rate, it makes the tax burden of completing the sale onerous. Contractors, plumbers, electricians, dry cleaners, restaurant owners will all be affected. This is not a “Wall Street only” issue. It is a “Main Street” issue as well.

Impact on Racial Inequality

Robert Johnson, founder of Black Entertainment Television and a very successful businessman, explained recently how raising corporate taxes and capital gains tax rates will harm black owned businesses. Mr. Johnson was a guest on CNBC Squawk box explaining a plan he proposes for providing tax breaks for investments in black-owned businesses.

Raising Corporate Taxes Harms Black Entrepreneurs

Mr. Johnson pointed out that raising corporate tax rates just reduces the amount of capital available for black businesses. He was interviewed in relation to a plan he proposes where black-owned business should get tax advantaged treatment. Raising their taxes runs counter to that goal and of course stifles economic prosperity for people of color.

Raising Capital Gains Rates Harms Black Owned Private Equity Firms

Mr. Johnson further explained that the Biden plan proposing higher taxes on capital gains is a major blow to Black-owned private equity firms. Mr. Johnson explained that a number of Black-owned private equity firms are “just getting started” (in his words) so such a change in tax policy could damage or totally obliterate their business models.

Since such firms have raised or are raising capital on the basis of a reasonable capital gains rate below the earned income rate (not above it as explained previously) a capital gains rate increase as proposed by the Biden administration essentially puts these new firms out of business.

There are so many unintended negative consequences from the plans put forth by the Biden administration that it is clear they need to be revised. Hopefully they will be changed as they travel through the legislative process.

In my next post I will propose some ideas for how to help the middle class, and also help with racial inequality. There are market-oriented approaches some of which would not require a dollar of tax increases. These would be preferable to many of the things that have been proposed in this tax plan. These are “new thinking” as opposed to “old thinking” (the New Deal was fine in 1932 but it is now 2021).

Economy and Business Politics and Public Policy

Democratic Economic Plans and their Long-term Implications

Caveat: I am not a Republican or a Democrat. I am writing this and other blog posts about the level of spending being proposed by the Biden administration and the associated tax and societal costs these programs present. I am producing these viewpoints to illustrate the impact the proposed spending may have on the economy and business as a whole.

The Democratic Party, led by President Biden have enacted legislation to deal with the Covid-19 crisis, proposed a multi-trillion dollar “infrastructure” bill that includes spending on things well beyond the traditional definition of infrastructure such as roads, bridges and airports. This bill introduces the concept of spending on things such as in-home elder care, museums, and affordable housing as infrastructure. They plan another large “Family Act” that is also reported to be a multi-trillion dollar proposal.

The spending enacted or proposed by Democrats is supposed to transcend $6 trillion. This is an amazing amount of stimulus to add to the economy and may spawn wide-spread inflation in the future. The associated tax plans being proposed (a subject for another blog post) to accompany this spending can have deleterious effects on capital formation in general with a large negative impact on entrepreneurial activity of all kinds (startups in technology markets as well as contractors, plumbers, electricians).

Not All Spending is Bad

The first bill signed into law included a great deal of immediate help for people who have been thrown out of work by the pandemic. This (Covid-19 relief) seems a compassionate and wise use of public funds, and does a lot of good for those affected. Workers from the hospitality and travel industries were displaced economically through no fault of their own. I fully support helping them and wish that politicians had not waited until the Biden administration came into office to help them.

The magnitude of the $1.9 trillion bill was debatable but in the end it was probably wise to make sure help was given to those in need despite the size of the bill. The bill had $350 billion for state and local aid (that many thought mainly benefited highly Democratic areas), but again with the pandemic crisis hitting tax revenues in so many places, it is probably best to err on the larger side of caution and to get help to beleaguered communities.

Some Spending is Debatable but Could be Infrastructure

The infrastructure bill is another matter. The bill contains a lot of good and justifiable projects (Amtrak, roads, bridges, electrical power grid). It also contains many things that are well beyond the definition of infrastructure. It is hard to understand how hundreds of millions of dollars for museums (even though I love museums), Native American language preservation, and underground transit in Silicon Vally (a known earthquake zone) are valid infrastructure projects.

The infrastructure plan also includes items that are aimed at environmental causes and social problems. I think it is fine to expand the definition of infrastructure to broadband network expansion, electrical grid improvements and even projects involving highway infrastructure for electric vehicle charging.

Encouraging the use of electric vehicles may best fit into a transportation bill rather than an infrastructure bill, but I can see it related to electric power grid and vehicle charging projects (which can be seen as infrastructure along with bridges, roads and airports). Including these electric vehicle projects in a transportation bill instead of an infrastructure bill could allow them to be funded out of fossil fuel taxes instead of general tax increases. This may better fit the climate change agenda by trading fossil fuel disincentives for electric vehicle incentives. It may also ease the burden on income-tax payers overall while encouraging more ecologically responsible behavior.

Some Spending is Debatable and Not Really Infrastructure Anyway

Plans that are purely social programs (elder care for $400 billion and affordable housing, the aforementioned Native American language preservation, etc.) are totally suspect and seem disingenuous (when included as infrastructure). The cost of these and the fact that they are included with infrastructure when they are clearly social programs makes we analyze the intent of including them in an infrastructure bill.

Calling elder care “infrastructure” and now coining the term “human infrastructure” to describe them seems intellectually dishonest. Arthur Brooks of Harvard University and previously of the American Enterprise Institute made that statement on CNBC on April 19th of this year.

Mr. Brooks’ point was that something like elder care should be in “other bills” and that we should fairly and honestly debate them on their own merits. Including them in an infrastructure plan and then pushing this through with budget reconciliation and Vice President Kamala Harris casting the deciding vote (should all Democrats support the plans) seems to fly in the face of true bipartisan leadership. It looks more like a calculated political strategy to push through a far-left agenda.

Including them with an infrastructure bill seems excessive and purely political. In the end the bill may get negotiated to something more traditional and less expensive.There may be some bipartisan support if the social programs are removed and the infrastructure bill is amended to include more traditional projects. But it does seem likely that Democrats will push this through which can sow the seeds of discontent that may cause political problems in the future.

We have to wait and see on the other proposal for American Families. Many of the things that have been advertised to be in the proposal for “American Families” are noble and worthy of consideration but as our country is still dealing with the economic problems of a pandemic induced recession the timing and size of these plans concern me. Many of the things in the infrastructure plan and the American Family plan seem like good things to do, I just worry about their cost and the inflationary impact that they may have in the future.

Aggressive Agenda May be “Pyrrhic Victory”

Pushing these large spending programs through with budget reconciliation “because they can” will probably come back to haunt the Democrats at a later date. The political pushback of appearing to push an agenda that seems excessive and liberal may not be worth the good they think that they are doing. Not everyone in the country buys the “invest in America” message being espoused by the Democrats. Not everyone believes that bigger government works equitably and efficiently. We have seen over time that many of these liberal ideas can be reversed in a subsequent election. So rather than getting something with a more traditional set of legislation, this “swing for the fences” and spend trillions of dollars approach can inevitably backfire on Democrats.

Overall Impact on Economy – Inflation

The impact of this kind of spending will inevitably be inflationary. Inflation hits the poor disproportionately hard as it raises costs faster than wages can raise to meet them. It seems like a wiser approach would be to propose more rationally sized bills that can garner some bipartisan support. Having more of us agree on a path even if it leads to a less grandiose outcome than envisioned by Democrats is a good idea.

Economy and Business Politics and Public Policy

Time to Rethink Trillions

Mitch Albom is a thoughtful author and columnist. Recently he wrote this piece for the Detroit Free Press: “Mitch Albom: A trillion dollars is not a billion; why you can’t just print money”. In the article he lays out how spending at the rate we are on large social programs will have a cost, a very large cost.

In the article he explains how politicians are as Rahm Emanual said (para-phrased): “not letting a good crisis go to waste”. I don’t think that Mitch Albom is a partisan individual and don’t think he is favoring one party over another in his analysis of what is historically massive spending on huge government spending plans. The CARES act last year amounted to $2 trillion and was sorely needed but adding on the nearly $2 trillion “American Rescue Plan” last month, followed by a proposal for a $2.3 trillion infrastructure bill described as “The American Jobs Plan” with an advertised $2 trillion “American Family Plan” (soon to be proposed) seems to be incredibly excessive. 

Mr. Albom points out the inevitable devaluation of the US dollar that will result with such an infusion of capital into the economy, and inevitable inflation that will ensue and reminds that this hurts all of us in the long run. Besides higher taxes that always end up hitting the middle class, these programs don’t promote economic growth as they are purported to, and eventually become economic anchors as everyday Americans end up paying more and more of their income to the government which redistributes it unevenly in a way that does not benefit everyone. 

The important points that Mr. Albom makes include that the American Rescue Plan (in Joe Biden’s words) is aimed at “the very health of our nation” with the sales pitch being that it addresses the Covid-19 pandemic. The truth is that (again as Mr. Albom points out) the bill includes more money ($350 billion) for state and local government assistance than it does for direct aid related to Covid-19 vaccinations. Spending on state and local governments that have badly mismanaged pension systems is not directly related to health initiatives. It seems more targeted at helping governments with mostly leaders from the democratic party. This may help ensure democratic electoral success in future elections. This does not seem like wise spending to address “the very health of our nation”.

With the American Jobs Plan (infrastructure) items include $1.5 billion for Amtrak, and hundreds of millions for museums, Native American language preservation, and underground transit in Silicon Valley (a known earthquake zone by the way). The Amtrak expenditure is infrastructure related, but museums, language preservation initiatives, etc. may be lofty goals, but don’t seem to belong in an infrastructure bill. Spending on these types of programs may be aspirational for a minority of the American people, but it does not seem like wise spending in the context of a bill intended to address infrastructure issues.

The infrastructure plan includes more spending on programs to encourage the use of electric vehicles ($174 billion) than on actual construction of roads and bridges. Personally, I am a proponent of electric cars, but this is really an item for combatting climate change rather than something that belongs in an infrastructure bill. Going beyond this, another layer of audacity seems to be the inclusion of $400 billion in spending on senior and disabled person care, affordable housing ($300 billion) and another $35 billion for researching climate change. These are all worthy notions but packaging them into an “infrastructure bill” and selling them on that basis is dishonest. It will eventually lead to more political division as the debt burden will mount on ordinary citizens due to the cost of the programs (which may have no clear tangible benefit).

President Biden is probably a well-meaning and decent man. He has only lived in his adult life as a lawmaker in Washington and does not understand what life is like in the country as a whole. He has no idea how to run a business, meet a payroll, or build an economic entity (a business). He is a politician who believes in big government and wants to preserve power for his party, the Democratic Party. As we have seen over time, the party in power (democrats in this case) always overreach and push too liberal an agenda. In general, all politicians do this by pushing too liberal or too conservative an agenda (depending on who is in power). In this case, Biden is falling into the trap of assuming a mandate that does not really exist. It will lead to more political division within the country.

The Biden administration and the Democratic legislature is pushing a very liberal agenda and acts as if it has a huge mandate. The last election for the house and senate was not a sweeping mandate. The election results not related to our past President were not totally liberal (many voted against President Trump because they wanted a more reasoned and polished approach to government than his administration had provided). Many voting against Trump were not particularly liberal in their views at all. The election as a result did not produce a “Blue Wave” as many in the press and Washington seem to believe. The house of representatives lost seats to the republicans and if our past President had not been so hyperbolic and erratic toward the senatorial runoff elections in Georgia and had not pushed his “stolen election” narrative, the Senate may still be in Republican hands.

 In actual fact the country as a whole is not as liberal as the major east and west coast cities. The large spending and dishonesty over what the infrastructure bills contain will cause a backlash against the Democratic party. Our prior President was such a polarizing figure that it is easy to feel more comfortable with a President who is acting more “presidential” than the prior one. President Biden is much more gentlemanly and behaves in a more “presidential” way than Trump ever did. The mistake that President Biden is making is not just assuming that he has more of a mandate than he does, but also under-estimating the backlash that he is forming within the electorate. If Trump stays off the stage in 2022 then the Republicans are very likely to regain the house and the senate if this liberal agenda continues.

When the tax hikes that President Biden articulated in his campaign rhetoric are proposed, the illusion of a mandate will quickly evaporate. The citizens now are happy to receive checks, get extended unemployment assistance, and other promised government benefits. When the tax bill comes due on ordinary Americans (as it always does and no matter what Biden says it will fall on the middle class) then the electorate will no longer support the wild spending in Washington. The democratic party leadership will have overstepped its bounds and the political tables will likely turn. Biden would be wise to control members of his party who have such an aggressive agenda. Coming out of the “pandemic economy” the country and electorate need time to heal. President Biden is nearly inviting a backlash election that opens the electorate back up to “Trumpian” politics.

So it would seem prudent for President Biden to be mindful that pushing his policies of “trillions and trillions” of spending on an electorate that really does not overwhelmingly support that kind of spending is likely to be a losing proposition in the long run. It will also sadly push an enormous debt burden onto the American people for generations to come. This will inevitably reduce the quality of life here in the long run and sow the seeds of political strife in the short run.