Tesla would never have become a global leader of innovation, with an immense gravitational pull on the world’s top talent, had Elon Musk lost control of the company. Even a few years ago, it wasn’t clear the company would succeed. But America will attract fewer courageous entrepreneurs like Musk and produce fewer companies like Tesla if Congressman Ron Wyden’s Billionaire Unrealized Income Tax ever becomes law. Under this bill, the more successful a company is, the less its founders and early investors will be able to keep control over it. He is essentially telling our top innovators if you build it, Congress will take it.
As a founder and venture capitalist I know that revolutionary companies like Tesla are often misunderstood by the investment community for years. Many would fail without the ownership, vision and persistent execution of their founders and early investors. American venture-backed companies, including those founded and financed by my firm 8VC, create cutting-edge vaccines, revolutionary cell therapies, and trail-blazing defense technologies to solve the world’s biggest problems. We bring down costs with logistics and healthcare innovations, and are creating the infrastructure of the future with affordable electric vertical take-off and landing machines, more affordable housing construction techniques, technology to make government regulations and cities more efficient, and more. Covid-19 vaccines were developed just days after the virus arrived on our shores as a result of decades of venture investment. Still more companies like National Resilience Inc, which 8VC co-founded in the advanced bio-manufacturing space, ensures America has reliable and affordable access to new breakthrough therapies – including on-shore vaccine manufacturing and gene therapy supply chains. The generation born today will have better access to both high-paying urban jobs and low-cost rural housing after venture-backed companies like Boring Co. build an efficient underground transportation network. America’s innovation ecosystem will continue to improve life for hundreds of millions of Americans if we allow it.
Wyden’s tax would erode America’s advantages in creating world-class start-ups. Under the proposal, language for which was released October 27th, Americans with a net worth of $1 billion, or three years of income of at least $100 million, would be subject to annual taxation on the unrealized capital gains of their company holdings and other assets. The system would be inaugurated with a one-time tax on unrealized capital gains as if those assets had been sold, ironically effectuating a massive asset sell-off to pay for the tax. Wealthy Americans would then owe taxes on gains in valuations each year, and would often need to sell assets to pay the IRS. Tax payments on illiquid assets, such as closely-held companies, could be temporarily deferred at the cost of additional interest charges. Americans who simply consume their wealth rather than build new technologies would face no new taxation.
Imagine a serial entrepreneur who invests $10 million to finance a 50% ownership stake in his own start-up. As the company grows, he would be taxed out of his ownership position even if he drew no income. Suppose that after five years the company IPO’d at a $2 billion valuation and the founder was forced to sell stock to pay the state and federal unrealized capital gains tax – say at a rate of 33%, meaning he owes just under 330 million. He would have to sell a third of his holdings to pay taxes on the two-thirds he keeps, and his ownership stake would shrink to 33% with no cash out. At a $5 billion valuation a year later, he would owe another ~$330 million in taxes, forcing him to sell 330M worth of shares to pay taxes on the rest of the holdings – assuming he could even find a buyer for these massive stakes at a fair price! Now he’s at 26.4%, assuming no other dilution. If you add in normal dilution on top of this, say 40% with a couple big fundraises needed to pursue the ambitious vision, now he’s down to 15.8% – back under the billionaire level. But at a $20 billion valuation in a couple years, he would have to find buyers for another $780M of his shares just to cover his taxes, and he’s down to 12% ownership. In a couple more years if this is a highly successful company, he’s down to ~5%. The more the company grew, the less of it the founder would keep. Under this regime, Elon Musk might well have lost control of Tesla before he could turn it into a spectacular success – and his incentive might have been to just focus on the next company, instead. Or worse, his incentive might have been to keep the company smaller for longer and keep the valuation down and private until he is ready to grow even faster in valuation all at once, given the path-dependent nature of ownership under this tax!
Wyden’s tax would create a slippery policy slope for future policymakers to subject more unrealized capital gains to taxation. Federal and state tax revenues would swing wildly. One year a taxpayer could owe $40 million in unrealized capital gains, and the next he could have a $50 million credit for unrealized capital losses without ever having sold an asset or booked a profit. No well-managed state would try this tax because of the complex administration and volatile revenues. Besides that, founders would simply leave.
A large part of our society has growing envy over wealth creation, perhaps thinking these creators are stealing it from others and not understanding the positive sum nature of innovation. But either way, we should stop and remember that the vast majority of wealth is not controlled by the Elon Musks, Bill Gateses, and Jeff Bezoses of the world. All of these entrepreneurs’ wealth added up is a tiny drop in the ocean versus the annual trillions in spending by our local, state, and federal governments. A huge amount of progress and breakthroughs come from the spending and charity of our top innovators – I don’t always agree with Bill Gates, but thank goodness we have endowments like his versus only government bureaucratic committees who are investing in our future and confronting the problems we face in today’s world. Our society should be thankful for its wealth creators. And besides, expropriation is in fundamental contradiction to the American principles of liberty and property rights. A tax on unrealized capital gains likely violates the Constitution and should be struck down in court.
The U.S. already has one of the most progressive tax systems in the first world. If lawmakers want to further tax high net worth individuals, particularly those who finance their lifestyle by borrowing against stock holdings, they should progressively tax consumption. Reasonable tax changes can be made without crushing American innovation or driving away our top founders, whose work on the whole lifts up everyone and creates greater prosperity in our system.
Congress should preserve a tax code that fosters the miracles of our innovation ecosystem, which has consistently outperformed the rest of the world. Taxing unrealized capital gains is simply misguided – it reminds me of an old cartoon where there is a pesky fly the protagonist chases all about the room, destroying the curtains and damaging walls and all the furniture in the process of attempting to swat it. Let’s not allow puerile envy at great success to bring us all down. It’s no exaggeration to say that only a small fraction of innovative US companies and groundbreaking technologies would come into existence if we end up making an unrealized gains tax the law.