Taxes on Tech Need An Overhaul—But Not Like This | Backchannel
In the Silicon Valley storybook, the stock option is a kind of magic talisman. Options carry tiny startups aloft by motivating founders to superhuman levels of exertion in pursuit of colossal payouts. They give everyday employees of these companies a power-up, too—a feeling of ownership and a chance to cash out and buy a house or send a kid to college. They cast a spell of unity, aligning the interests of managers with those of shareholders. In boom times, they seem to make fortunes materialize out of thin air. During busts, their value vanishes like snowdrifts in spring. The risk only adds to their mystique.
Now Congress, like some jealous sorcerer, is talking about shutting down the options magic. The GOP tax plan includes a provision that would change how stock options are treated. And if you listen to the chorus of protests from industry insiders and startup Twitter, the plan would stall tech’s “engine of innovation” and stifle everything that makes Silicon Valley special.
But I don’t think it’s so crazy. And ultimately, this flap might prove beneficial.
The GOP tax plan doesn’t actually impose a new tax on options compensation; it simply changes when taxes on options (and another form of stock compensation called RSU, for “restricted stock unit”) kick in. The details are arcane. Stock options are, literally, a right a company grants you to buy shares at a price set in advance. If that price ends up lower than the market price, boom—your option is “in the money.” If it’s higher, then you are “underwater.” Companies typically don’t hand employees passels of options outright; they’re granted on a schedule of vesting, usually four years, to reward loyalty and encourage talent to stick around.
Right now, the “taxable event”—the moment when the IRS demands its share—is the moment you exercise an option (i.e., you actually buy yourself some shares at that price the company originally offered). The new proposal moves the tax earlier, to the moment the option vests—when it transformed from a promise made by the company (“stick around and we’ll give you these precious spells!”) to a right you possess.
Here’s where the outrage kicks in, because the option isn’t liquid unless you exercise it—and to pay a tax, you need dollars, not rights. As Fred Wilson, the celebrated venture capitalist blogger, puts it: “You can’t spend it, you can’t save it, you can’t invest it. Because you don’t have it yet.”
But you do have something: a contract. Its value is volatile, sure, but not entirely impossible to calculate. (The next time you have trouble falling asleep, Google “Black-Scholes model.”) The senators who are proposing a tax on options vesting aren’t crazy. If the IRS can devise tax rules that cover complex abstractions like depreciation and “pass-through income,” why not vested options?
The important question about the options tax isn’t “how,” but “why.” Short of military force or criminal justice, taxes are a government’s most potent policy weapon, and the real question to ask about any tax is: What does it accomplish? Who wins and loses, and are we all better or worse off?
Right now, it looks like the Senate proposal is just another item on a long list of revenue-generating changes meant to prevent the tax package’s big cuts from ballooning the federal deficit. By one estimate, the options change would add $13.4 billion to the US treasury over a decade. That’s chump change for an Uncle Sam with trillions in debt.
So why do it? Some see the options tax as a cudgel to bash Big Tech—a manifestation of the current wave of hostility to the industry’s increasingly giant-vampire-squid-like nature. (Senator John Kennedy of Louisiana to Facebook at the recent hearings: “I do find your power breathtaking.”) But anyone on Capitol Hill who thinks the new options tax rules will punish Google, Facebook, Amazon, and Apple for their hubris is sadly misguided. As critics note, the proposed rules will mess with small startups way more than with entrenched leviathans. When you’re sitting on hundred-billion-dollar mountains of cash, it’s easy to find ways to help employees maneuver around irksome tax obstacles. Cash-poor startups offer options precisely because they don’t have a lot of spare dollars lying around. If the Senate plan or something like it becomes law—and, given the labyrinthine tax legislation process, that is nothing like a done deal—you can expect the whole business of granting options to dry up, disrupting the teeming ecosystem of small new firms.
On the other hand, this is not exactly Armageddon. As noted, it’s not as if the current system did much to limit the emergence of Silicon Valley’s ruling oligarchy. However you name and count them, whether you call them “the frightful five” or “the big four,” the platform giants have already cornered the tech market.
Nor have stock options been world-changing in conferring the other boon they promised: spreading the wealth more widely among a broader base of tech employees. And the system as currently structured is far from equitable. There are plenty of cases where employees find their options diminished or worthless because venture capitalist investors made deals to get paid before the option pool kicked in. Overall, though options have made plenty of founders rich, they’ve done nothing to alter the trend of sharpening inequality in the US economy.
The Senate plan has rallied tech’s legions to fight to preserve the status quo. But maybe, instead of protecting the flawed system now in place, we should be thinking of new kinds of tax policies that actively clear a fresh space for sustainable innovation. What about taxes that create an incentive for companies to dole out options widely? You could make the tax rate progressive, with a higher rate applying to higher concentrations of ownership. What about taxing the platform monopolists for their appropriation of our personal data? Maybe we should be experimenting with tax breaks for benefit corporations, “triple bottom line” entities, and similar efforts to rethink social responsibility in the corporate world.
“Give me a lever and a place to stand,” said Archimedes, “and I’ll move the earth.” Taxes are our levers for moving the economic world. Tech is a fine place to take a stand. Taxing stock-option vesting may be a poor idea—but it could pry open an important conversation.
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