What the Government Could Really Do to Support Entrepreneurs

Innovation and entrepreneurship are becoming my two least-favorite words, mostly because they are being appropriated in ways that are neither innovative nor entrepreneurial. Like in today’s New York Times essay by Tom Friedman.

Friedman used to be one of my favorite writers. In Beirut to Jerusalem, when he talked about two sheiks on a flight to the Middle-East tossing bricks of gold back and forth, he was compulsively interesting.

But now that Friedman is back in the U.S., he occasionally seems less like a world-wise foreign correspondent than a credulous, honey-didja-see-that tourist. This article on entrepreneurs is just a bad example. First, he doesn’t bother to talk to actual entrepreneurs. As he himself admits, his essay mostly comes from two academics at non-profit institutions:

I asked two of the best people on this subject, Robert Litan, vice president of research and policy at the Kauffman Foundation, which specializes in innovation, and Curtis Carlson, the chief executive of SRI International, the Silicon Valley-based innovation specialists.

What’s odd about Friedman choice of sources is that he opened the essay by criticizing the Obama administration for being too “heavily staffed by academics, lawyers and political types.” Yet his first source, Robert Litan — a great thinker and writer — is three for three: he worked as an academic, studied law at Yale, and often writes government reports (incidentally, Litan also wrote an essay in the New York Times that prompted us to testify before Congress). The other source, Curtis Carlson, lists his primary avocation as the violin.

True to form, these folks have proposed a new government department of entrepreneurialism, headed by a cabinet-level minister called “Secretary Newco.” Like low-salt Chinese cooking, this sad phrase is a contradiction in terms: what government minister is an entrepreneur?

Friedman briefly mentions an entrepreneur’s visa, which is a worthy goal, but then suggests we offer a visa to any foreign student who graduates from a U.S. college. Regardless of how I may feel about immigration, this is an overly broad, unrealistic suggestion: someone who studies hotel management at UNLV isn’t likely to start a company just because she’s from the Congo or Italy.

Friedman then proposes “cut[ting] the capital gains tax for any profit-making venture start-up from 15 percent to 1 percent.” This is nonsense: a venture-funded startup usually isn’t “profit-making,” and in any event a startup doesn’t pay capital gains taxes. Employees and investors pay capital gains taxes when selling the stock of a company that was, at some point in the past, a startup.

Moreover, the capital gains tax as it stands is not a problem: the most tax-efficient way to become a millionaire is by selling stock in your own company. You pay a lower tax rate on that money than most middle-class Americans. Friedman also calls for lower rates of corporate income tax on startups, even though a startup would only pay taxes once it began making profits. In four years, Redfin has barely paid any corporate income taxes, and now that we sometimes earn money, we don’t mind the tax.

The errors continue, with Friedman riding the old battle-horse to repeal “Sarbanes-Oxley reporting for new companies.” But new companies don’t have a Sarbanes-Oxley reporting requirement. Sarbanes-Oxley only applies to publicly traded businesses, which are usually at least five years old.

Even if Friedman is talking about lifting Sarbanes-Oxley requirements for companies in their first few years as a publicly traded stock, I think he is missing the point. As we’ve argued before, the reason for the dearth of IPOs hasn’t been due to Sarbanes-Oxley laws but because, a few years ago, so few startups were generating consistent profits, and so few entrepreneurs were interested in the long haul.

Finally, Friedman talks about policies that “encourage private investment.” He seems oblivious to the fact that too much money is what’s breaking venture capital right now. We don’t have a shortage of capital, or even a shortage of ideas. We have a shortage of engineers.

And this is precisely where government can help. My alma mater, U.C. Berkeley, has long been one of the principal sources of engineering talent in Silicon Valley. Last year, Berkeley was forced to cut its budget by $813 million, or 20%. Top-flight professors are leaving the nation’s leading public university in droves. The same scene is replaying itself across the U.S., including here in Seattle at the University of Washington.

You would think the whole Valley would be up in arms over such a calamity. I for one wish Friedman would have mentioned undergraduate education somewhere in his essay. Within the technology community, we all know that the reason America is #1 in technology isn’t because of our regulations, cabinet ministers or tax code; it’s because we have had the best universities in the world, which produce the best thinkers, scientists and engineers. We have only recently come to realize how delicate those universities are.

This is why I just can’t bear to hear folks talk about Secretary Newco, cutting the capital gains taxes for millionaires and billionaires, or eliminating the Sarbanes-Oxley regulations that emerged after Enron struck the first of many blows against our faith in public markets. Our once-proud research institutions are struggling to fulfill their mission in society. They need the government’s support. They need Tom Friedman’s support. They need your support.

If we’re going to rally behind a cause, we don’t have to look further than that.

Discussion

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  • Mason B.

    Wow, great post! As a lawyer I am often surprised by how often people believe we would be better off if we just made the stack of federal law books a bit taller or added a new federal agency, as if generating paper is a magical fix all. The things that matter are the people performing real actions (like the professors you mention or the engineers behind new businesses), not the creation of bureaucracy. It will be interesting (and perhaps sad) to see the long term effects of this recession. The departure of teaching talent in schools likely will not manifest itself fully for 5-10 years.

    • http://blog.redfin.com GlennKelman

      What's most distressing about the sudden vogue for entrepreneurialism is the search for some quick-fix stimulus to drive entrepreneurialism immediately. Whatever skills I gained as an entrepreneur were imparted to me ten years before I ever started a company.

  • Brad Gillespie

    Agree completely … particularly about education.

    One thing that stands out to me is that often discussions about entrepreneurs seem to happen through the lens of venture-backed technology startups. There are many other types of entrepreneurs in this country as well.

  • http://www.davosnewbies.com lknobel

    Absolutely on target, Glenn. The neglect of the great state universities and, even more worryingly, of K-12 public education, is storing up enormous problems for our future. I'd rather read you twice a week in the NY Times. Too bad you're busy running a company.

  • joewallin

    Glenn, great writing! I have to admit though that I am a believer in the concept of lower taxes being a good thing….and I think that for many small companies that can't get venture funding for whatever reason (and there are lots of these companies, and many of them are great companies), I think that a zero percent capital gains rate for investors in those companies would cause investors to seek them out and invest in them more aggressively, and that would be a good thing. I also agree with Mason's comment above though that we ought to be repealing a lot of laws that get in the way of doing business, to clear the decks for a more competitive and vibrant marketplace.

    • http://blog.redfin.com GlennKelman

      Good point Joe, but do you worry that a company like GE would spin out a new venture that it owned a large chunk of, so that the profits would be untaxed? Maybe this solve the too-big-to-fail problem…

      And how do we support great universities on lower taxes?

      • joewallin

        Glenn, under President Obama's proposal, GE couldn't do this because it wouldn't work under the qualified small business stock rules. http://bit.ly/8sS4CE
        On your second point, I think if we create great companies, taxes will come…albeit from different sources than capital gains taxes on qualified small business stock.

  • Alex Loddengaard

    Excellent post, Glenn. Inspiring as always!

    PS: this new blog comment setup is pretty sweet :).

  • Alessandro P.

    Great post and great analysis. Friedman is usually on target but clearly he has not thought about this long enough. Unfortunately in Washington we don't need a “secretary newco,” but rather a secretary “nuke-o”

    • http://blog.redfin.com GlennKelman

      Alessandro, you slay me…

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  • pv

    Great article, Glenn. These problem, as many others our government presents as hard or even “unsurmountable”, is not that hard in reality for a rational mind. A lot of problems scientists and engineers deal with every day are significantly more complex, yet the problems are being resoled, unlike, it seems, ANYTHING in our government policies.
    If they would really be interested in what prevents people from creating startups, maybe they should ask would-be started creators who are prevented from starting their own businesses and creating jobs? Like me, for example. What do I need?
    Some things are very simple, for example, I need access to Medicare (at actuarial cost, not at subsidized rates for seniors who paid Medicare tax all their lives). I am not a student, I need to make sure I and my family are covered in case of medical emergency. I am willing to risk money, but not health and life of me and my family. But instead of giving me that “public option”, the recent healthcare bill adds tons of regulations and make me, if the business ever grow a little, provide health insurance for employees. I SHOULD NOT SPEND A SECOND OF MY TIME THINKING ABOUT THAT.
    Some are more complex. I have plenty of ideas, I know how to make a software product, I know the people who could help me make the product… But I have no inclination nor ability to deal with all the government-mandated paperwork, collect receipts etc. If I am already risking my money while starting a business, I should not worry about hiring an accountant, an attorney, HR etc, and still risk jail or fines in case I missed something. I have no extra money or time for that. I would be glad to pay the same money in taxes, if oil lifted here or imported was taxed instead of income and wages, and I would pay them while refilling (as a higher gas price) without filing a single line of paperwork. AND it would be great for our energy efficiency and global competitiveness, AND spur a great natural (from private demand) growth in green startups.

    Unfortunately, Washington and most of the press are not interested in rational ideas. All they do is serving those who pay they way to DC. For example, those “1% capital gains tax” and “Sorbannes-Oxley” “ideas” are obvious plugs to make those who are rich without work even richer.

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