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Why Entrepreneurs and Obama Should Care About Capital Gains Taxes

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OBAMA ENTREPRENEURS TAXES
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I had the privilege last week of interviewing Steve Case, on stage, in a sold-out, standing room only event hosted by the Northern Virginia Technology Council.

Steve has been active lately as an angel investor through Revolution Ventures, as a late stage investor through Revolution Partners, as a cheerleader for entrepreneurship, running the Startup America Partnership, and as an advisor to President Obama on the President's Council on Jobs and Competitiveness.

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I interview Steve Case (right) at the Titans Breakfast Series.

While we covered a range of topics, including many of the recommendations the Council made to President Obama last week, let's address one of them - a zero percent capital gains rate for startup companies.

By way of background, it is a well-known fact that small companies in the aggregate create more jobs than big companies do. In the last ten years, larger companies shed jobs on a net basis. In other words, all of the net job growth came from small companies. Most of these jobs came from young small companies.

It is these young, growing, startup businesses that we need to encourage.

One of the recommendations to the President was for a zero percent capital gains tax on startup companies where the stock is held for more than five years.

This is a good idea.

But I pressed Steve on whether he thought this might actually be something the President would sign into law - in light of the "Buffet rule" he is proposing, which effectively creates a new Alternative Minimum Tax rate for the wealthy, effectively eliminating any favorable capital gains tax treatment. Ever the diplomat, Steve answered that many young companies are funded by not-so-wealthy angels writing $1,000 or $2,000 checks. While he may be right, technically, I don't think that most of the high-potential startups are growing up on $1,000 checks. $100,000+ is more like it.

So how do you take a good idea - zero percent capital gains for startups - and make it a big idea, an idea that could turbocharge innovation, company formation, and job creation in our economy, right now?

I suggest four simple ideas that are easy to support. They don't cost the treasury any money - and are likely to generate substantial additional tax revenue if the Congressional Budget Office would use a dynamic scoring algorithm. Here they are:

1. Extend the short term capital gains rate (which is your ordinary income tax rate) from a one-year holding period to a three-year holding period. This will generate substantial additional revenue immediately as assets held between one and three years will now be subject to ordinary income tax rates. More importantly it will encourage a culture of holding assets and building for the long term. The losers will be the speculators, buying houses or stocks and hoping to flip them for a profit in a short period of time. I am OK with that.

2. Have the current long term capital gains rate of 15% kick in at year three, and extend out to year five. This is revenue neutral as assets held 3-5 years are currently taxed at 15%.

3. Introduce a long term capital gains tax rate of 0% for assets held longer than five years. No exceptions. Let it apply to stocks, houses, and private companies. And let it apply to everyone regardless of income. This will cost the treasury money, but will likely cost less than the extension of the short term holding period brings in.

4. Encourage people to take a career and financial risk working for a startup by making clear that all employee stock options issued to employees during the time that a company is private are taxed under the three capital gains rates above. The rules for incentive stock options and non-qualified stock options are too complex today, and most average workers end up paying ordinary income tax rates while the investors and company founders pay capital gains rates. That isn't fair and should be fixed.

What do you think? Would you support an idea like this? Weigh in here or send this to your elected official.