DC’s Growing Startup Economy Needs the Technology Sector Enhancement Act

July 17, 2012

9:07 am

While many recent headlines focus on the scandals swirling around the DC mayor’s office and City Council, it is important to focus on the progress that the DC government has made in supporting the city’s growing startup economy. Last week, for example, the City Council passed a set of performance-based tax incentives to keep LivingSocial in DC for the foreseeable future.

The next startup agenda item for the City Council is the Technology Sector Enhancement Act [PDF]. The Act seeks to reduce the capital-gains rate paid by DC angel investors who invest in DC technology startups from almost 9 percent to 3 percent, making DC’s capital-gains tax rate competitive with other jurisdictions. For example, Virginia’s capital-gains tax rate for tech investments is almost 9 percent, while Maryland’s is 4.8 percent.

Why is giving wealthy investors a break on their taxes something that the community should support? Simple: we need a new engine for job creation in our city and region.

The Role of Startups

Over the past decade, our regional economy has benefited tremendously from enormous and unsustainable spending by the federal government, first to respond to the attacks of 9/11 and then to combat the effects of the financial crisis. We’ve seen unemployment and income growth rates substantially better than other parts of the country, a trend that continues today. Given that the spending of the past decade was unsustainable in the first place, however, we must acknowledge that we cannot count on the federal government to be our jobs engine for the next decade.

So what is going to create jobs in our city going forward?

If you look carefully around DC, you can see the answer already emerging: startups. Over the past 30 years, high-growth startups have created the vast majority of all net new jobs. As the federal government retrenches, we’re lucky to be benefiting from the tireless work of people like Peter Corbett and Jonathon Perrelli to build a sustainable, grassroots startup economy in the city. Month after month, you can see the number and quality of startups improving, which leads directly to high-value new jobs.

Given the positive growth in the DC startup economy, it would seem that policymakers just need to sit back, not mess things up, and let our entrepreneurs do their thing. In general, I strongly agree with this view, except that there’s a minor issue of scale. Startupland is growing significantly in the city, but it’s starting from a humble base, and the urgent need for job creation is immense. We don’t need to merely continue the growth of Startupland; we need to inject rocket fuel into the engine. We need order-of-magnitude growth in the number of high-quality startups that are being launched.

The Role of Angels

The lifeblood of high-growth startups is talent, connections, and capital. Organizations like Startup DC are working hard at tackling all three of these challenges. We worked with area universities over the winter to launch the Startup DC Student Career Fair, connecting startups and graduating students in the region. And we recently launched Reboot to connect our startups with established businesses. There remains much work to be done, but we’re making progress.

We still have a lot of work to do on capital formation, the third critical ingredient for scaling up Startupland. Venture capital has become remarkably fluid over the past few years. Sophisticated venture capitalists from across the country will cut checks anywhere they see an opportunity that has traction. At the earliest stages, though, getting a company off the ground still depends on angel investors taking a leap of faith on a passionate and credible entrepreneur. Without angel investors, there is no Startupland. Simply put, if we want an order-of-magnitude increase in high-quality startups in our region, then we need an order-of-magnitude increase in the amount of angel investing.

So it would seem that the Technology Sector Enhancement Act before the City Council is a no-brainer. Recently, however, the DC Fiscal Policy Institute released a blog post advocating against the Act on the grounds that it unfairly benefits wealthy investors. On the face of it, the DCFPI argument is appealing. We do have a ludicrously complex tax system in America at the federal, state, and local levels, which generally serves to distort incentives and protect entrenched industries. It also seems unfair to many Americans that a billionaire often pays a lower tax rate than his secretary or janitor. It’s never been clear to me that giving a wealthy individual a super-low tax rate on their capital gains from buying stock in Exxon Mobile or Best Buy really has any “trickle down” impact in creating quality jobs in America.

In this case, however, the DCFPI is focusing in the wrong place. The Technology Sector Enhancement Act isn’t about the investors, it’s about the entrepreneurs. The simple reality is that angel investing is an incredibly risky game. For every angel who cuts an early check for a LivingSocial or an Opower and brags about their 1,000x returns for years, there are many more who lose their investments or make modest returns.

Our community benefits immensely from these angel investments, however. A $10,000, $50,000, or $100,000 investment at a key juncture is what turns a great idea into an engine for creating hundreds or thousands of valuable jobs. The Technology Sector Enhancement Act isn’t giving a handout to fat-cat investors lording over their ill-gotten returns. It’s sending a powerful signal to high-net-worth individuals in the city: we care passionately about startups and want to reward people who take significant risk in ventures that could benefit our community for many years.

The pragmatic truth is that DC and other cities and states across America provide tax incentives for various industries all the time. For once, the City Council isn’t considering whether to give a handout to favored insiders, but rather whether to provide incentives to investors to help entrepreneurs create more disruptive new startups that are going to rock the status quo in DC and create the jobs of the future. Our Council should be applauded if it passes this Act, and I encourage all of you today to email your Council member and share your strong support for the Technology Sector Enhancement Act.

Guest author Evan Burfield is passionately committed to turning the DC region into the center of entrepreneurial efforts to reinvent America. A serial entrepreneur, Evan is the chairman of Startup DC, the chairman and founder of Synteractive, a mentor and limited partner with The Fort, and co-chair of the Thomas Jefferson High School for Science and Technology Innovation Network. He also sits on the boards of advisors for startups including Lemur, Ivy’s, Hallway, and Study Hall. Evan holds bachelor’s and master’s Degrees in philosophy, politics, and economics from the University of Oxford.

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Evan Burfield is passionately committed to turning the D.C. region into the center of entrepreneurial efforts to reinvent America. A serial entrepreneur, Evan is the chairman of Startup DC, the chairman and founder of Synteractive, the chairman and co-founder of Hallway.co, and a mentor with The Fort. Follow Evan at @eburfield

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