Wednesday, July 18, 2012

Does special interest legislation like the DC TSE Act make or break budding startups?

Evan Burfield, a prominent member of the DC startup community, yesterday posted a passionate endorsement of the DC Technology Sector Enhancement Act introduced by disgraced former council chairman Kwame R. Brown.

The TSE Act, which in essence is a special interest tax cut on capital gains for angel investors in the district is currently pending before the city council. The goal is to increase angel investment in technology startups in the district by lowering the local tax on such capital gains from 9% to 3%, thereby undercutting neighboring states of Virginia and Maryland.

While I'm not averse to tax cuts in general, and especially not when I'm part of the special interest group (entrepreneurs) who are supposed to benefit from it, I think it important to first establish that this tax cut actually will have any impact at all on the issues it is supposed to solve.

Is there any research that shows that tax cuts for investors will lead to more angel investment in cities like the district, and is even lack of angel investment a problem that needs solving in the first place?

Mr. Burfield (and many others) points out that the aggregation of talent, connections and capital in a region is crucial for the establishment of a thriving startup community, but fails to support with facts that the proposed act will have any impact on the problem.

In my view, tax cuts are not inherently good and in this case it is entirely possible that the opportunity cost of the forgone funds over the coming years will be significantly higher not only for DC as a whole, but even for the startup community. Ie that the funds would have greater impact when spent elsewhere versus be lost to tax cuts.

I am not alone having these doubts. 

John P. Ross, Senior Advisor and Director of Economic Development Finance Office of the Chief Financial Officer, testified that "research indicates that tax incentives are generally not a critical factor in corporate locational decisions". I may not agree with that statement in every situation but I think it is very true for startups. Have you ever heard of a startup that located to California because of the fantastic tax policy? I didn't think so.

Another problem with the Act is that it actually does not benefit startups directly at all, only their investors, who very possibly may not reside in DC.

My point is that, show us research that this tax cut will actually have any impact at all. If you can't, I think that it is very possible that a better use of money for startups in DC would be to let the city use it to continue the improvements over the past ten years to make the city more livable and attracting young, old and creative people to live and work in the city instead of dying a slow death in suburbia. 

That will create a pool of talent and connections that capital will follow.


  1. Niklas,

    Awesome to see you engaging in the debate about how to best grow startupland in the region. It's also cool to read that I'm prominent!

    I have a couple of thoughts on your piece:

    1. Back when I was immersed in academic economics, I spent more time than I care to remember pouring through all the research into whether tax incentives or fiscal expansion or nothing is more effective public policy. Despite huge amounts of data, the debate tends to end up something of a draw unless you have a particular ideological passion, in which case you see what you want to see. My own theoretical view is that the ideal public policy would be a simple, progressive system without any distortions (a "fair flat tax" if you will). Unfortunately the world we live in is very, very far from that ideal. My pragmatic answer dealing with reality rather than theory is that I think tax incentives directed at early stage investments in startups are more likely to have a positive impact on the community than just about any other incentive. There simply isn't enough data on such a narrow policy to definitive prove or disprove that hunch a priori though.

    2. I'm not sure the relevance Mr. Ross's observation that tax incentives aren't a critical factor in corporate location decisions. The Technology Sector Enhancement Act isn't designed to convince startups to move to DC, but rather to nudge more wealthy individuals to write checks to fund the entrepreneurs that are already here.

    3. I also don't think your point about the investors not being in DC is relevant. The TSE Act is written to benefit DC residents who invest in DC-based technology startups.

    Ultimately, the TSE Act isn't going to be decisive one way or another. If the City Council sits on it, then we'll all continue to bust our asses to recruit new angels from within the region and connect them up with promising entrepreneurs.

    The key point from my blog post is that the TSE Act sends a signal to wealthy investors that investing in startups is important to us as a community. It's only going to have an impact at the margin, but those margins matter when you're looking to get capital flowing.

    Evan Burfield

    1. Evan,

      First, thank you for taking the time to read my post as well as getting back with your thoughts!

      1. I agree on the general economics, and wasn't expecting the council or anyone else to review the history of economics on the matter. I was more thinking along the lines, has this been done anywhere else? What were the results? Could they be measured? Can we expect a greater payoff multiple than 1?

      2&3. Point taken. I was trying to get across the idea that this may partially be a chicken and egg problem where the TSE may not be all that relevant in the grander scheme of things, when trying to boost startups in DC. And if that is the case, the money may be better spent elsewhere, not only from the view of non-entrepreneur DC residents, but even for us entrepreneurs.

      I also think that the TSE Act is not going to be decisive, mainly because I believe that the factors boosting entrepreneurship in the city are largely (but not completely) independent from the TSE Act impact.

      I think the most important impact from the discussion around the TSE Act, and by that, I don't mean our blog entries but the fact that it has made it all the way before the council, is that the issue of technology startups (beyond LivingSocial) is now definitely on the radar from the DC government perspective. That has not always been the case and is testament to hard work by @corbett3000, yourself and many, many others.


      Niklas Munck