Manifesto

The Santa Cruz beach boardwalk was quiet at 10 am on a weekday morning in late October. The arcade was empty and only a few surfers could be seen out on the waves that pound the northern California coast that time of year. The amusement park next door to the Coconut Grove was still silent, and at first I assumed that my GPS had yet again taken me to the wrong place, but I entered the arcade anyway. At least I could get a good view of some beach volleyball players from there.

It turns out that my GPS got it right – the venue for “Branding the Monterey Bay Region to the Global Marketplace – Annual luncheon with Congressman Farr” was indeed located  next to a Ferris wheel.  The event, hosted by the Monterey Bay International Trade Association (MBITA) was designed to highlight the benefits of commerce in the region, especially international export commerce. Congressman Sam Farr, who was running for re-election, was there to keynote and most of his speech was quite predictable (this is a great place, we have farms, we have wine, we have tourism etc., etc…) BUT finally someone asked the question that was on everyone’s mind – “what will happen on January 1? Will we fall off the cliff?” Congressman Farr didn’t think so. He concluded that (regardless of who wins the presidential election) we would likely have last minute extensions. This is hardly news, but it is nevertheless annoying that nobody expects that our government can solve this most basic of issues.

But this blog post is not about the fiscal cliff. Everybody has already blogged about that and unless you are living on the beach, you know about the stakes, the tensions, the political posturing and the brinksmanship that is delaying the onset of fiscal responsibility. This post is not even about taxes (my favorite subject) and the fact that almost everyone in politics (including the President – better late than never) has finally figured out that having that highest tax rates in the world is not helpful when you are trying to keep business and jobs in the US (See http://rogerroyse.com/blog/2012/01/25/the-warren-buffett-tax/). This post is about the inaction that is dragging the US and, especially, the California economy down while the fiscal cliff sideshow diverts our attention.

I have blogged before about what other countries are doing to encourage innovation (See http://rogerroyse.com/blog/2012/02/16/startup-nation/). The US will clearly never go to a direct subsidy and I am not asking it to. I am simply pointing out what the competitive environment looks like. Against that back drop, companies establishing a presence in the US must face a restrictive immigration policy, high tax rates, inconsistent tax treatment, and a hostile legal environment. My hope is that the new Congress will address the following big hurdles that stifle innovation and inhibit economic growth. Here is my list,
my manifesto:

Immigration Reform.

The President mentioned immigration in his acceptance speech, which is good because our immigration policy is outdated and counter-productive. In the agricultural industry – the largest industry in the state of California – the existing H-2A temporary agricultural worker program has not met the needs of employers and workers.  A farm group has proposed a practical visa program that would reflect business realities. See http://www.agalert.com/story/?id=4820. In the tech world, the Startup Act 2.0 enjoys bipartisan support and is designed to create incentives for entrepreneurs to start new business.  See Congress Should Pass The Startup Act 2.0 for an excellent discussion of the Startup Act.

Our outdated business immigration policies have been a drag on the US economy and the first order of business should be to implement the entrepreneur visa program, allow green cards for foreign students with technical degrees, and raise the arbitrary caps on visas for highly skilled immigrants.

International Tax Reform.

I have harped on this issue before (see http://rogerroyse.com/blog/2011/11/26/the-territorial-tax-or-why-does-congress-hate-technology/) and I will do so again. The current administration’s approach has been to create US jobs by making it painful for companies to leave rather than making it beneficial for them to stay. If you want to see how well that strategy has worked, ask me how many of my clients now have Cayman Islands PO box addresses (Hint: A Lot). One of the best things that the Romney/Ryan campaign did was force the administration to loosen up a bit on this issue and propose lowering the corporate tax rate to 28%. It’s not great, but is better than where we are now. That was campaign rhetoric and the cynical might say that there is now no political reason that it will happen, but I would like to believe that Washington knows that we cannot remain competitive when we are lumped in with countries such as Japan when it comes to tax rates.

The answer is to drop the top corporate rate to 25%. At that point, we won’t have to worry about taxing the foreign expatriation of technology. It will stay here. ‘nuff said.

State Tax Fairness.

A more subtle issue is the increasingly frustrating practice of individual states stretching the rules to grab a bigger share of interstate revenues. Enterprises will spend $112 billion over the next six years on cloud related technologies according to Gartner’s Cloud Outlook. That’s a lot of potential for tax revenue. No one doubts that the states are hurting (save for
my home state of North Dakota, which is awash in oil money (See http://money.cnn.com/pf/america-boomtown/), but the result has been a crazy quilt of state and local sales tax and income tax nexus rules that make it almost impossible for a multi- national to know when they are subject to tax. Some jurisdictions have even taken the position that out of state concerns are taxable in in cases that the constitution clearly prohibits (yes Fort Collins I mean you). The worst part is the conflicting interpretations that states have taken with regard to “taxation in the cloud.” It should be called taxation in the “fog” instead, because the policies of some states demonstrate a basic misunderstanding of the industry.

Cloud services typically come in one of three flavors: Software as a Service, Platform as a Service, or Infrastructure as a Service. As a tax matter, those transaction scan be viewed as a provision of services, license of software, or rental of tangible property, each with different tax consequences. Sometimes that characterization by a state will result in a sales tax being due to a state. Sometimes that characterization will also result in a company having tax nexus (or presence in a state) justifying the imposition of sales tax collection or income tax payment in a state.  One fundamental problem is that the states have not been uniform in how they view these transactions, meaning that every multi state company must conduct a state by state analysis to determine what their tax exposure is. Because it can be so counter intuitive to someone who knows the difference between SaaS, Iaas and PaaS, they almost always get this wrong, and it shows up in due diligence when they get financed or sold.  This result is an unnecessary inefficiency and cost of doing business that could be addressed with uniform standards, but it is doubtful that 50 states will come to the same conclusions given how quickly the tech sector moves. It is time for a uniform multi-state compact, even if it has to be federally legislated. See our State Tax
Blog Post for an example.

Securities Regulation.

My favorite philosopher, Frederic Nietzsche, derided mass movements as “herd” mentality. According to Nietzsche, there was a hierarchy of supermen at one end of the
philosophical spectrum, and the “herd” or the crowd at the other end. Superman=good. Crowd=bad. Like Nietzsche was the anti-Christ, the JOBS Act is the anti-Nietzsche (at least on this one point). To the 2012 Congress, the herd or the crowd is a good thing, wise beyond all measure and capable of ferretting out the really juicy deals.

Or so it seemed when the whole idea of crowd sourcing first came up.

The 2012 JOBS Act authorizes and directs the SEC to promulgate regulations implementing equity crowdsourcing, or crowdfunding. Two provisions of the JOBS
Act are noted here: crowdfunding and the rules allowing public solicitation of accredited only investments.  So much has been written about the crowdfunding portion of this law that it is not even worth hyperlinking to (but I will anyway, see Is the JOBS Act evil? Or just misunderstood?). The “evil” in that piece refers to the paranoid suggestion (from bone headed regulators mostly) that legions of hucksters are lying in wait to use the JOBS Act to defraud gullible widows of their hard-inherited money, among others. The counter argument is that, because of the limits on the size of investments, an investor’s exposure would be sufficiently limited so that no one could really lose that much unless they were either (i) very unlucky or (ii) me (have you met my broker?). In actuality, the real evil is that the JOBS Act as enacted has strayed too far from its fundamental premise, i.e. that the wisdom of the crowd should decide.  So far, it is not looking like the crowd is going to have much to say about it, since advertising and solicitation for crowdfunded securities will likely remain limited. But enough about that. With a $1 million cap and the expansive audit and reporting obligations imposed on issuers and platforms, most of us are skeptical that this will go anywhere anytime soon. Now, if Congress were willing to increase the caps (the amount that any one individual can invest and the total amount of the offering) and allow public solicitation, then the intervention of the “crowd” might actually be useful in this process. I find it ironic that just as Nietzsche eventually drove himself nuts philosophizing about the herd, Congress is driving the rest of us nuts philosophizing about the crowd.

The changes to Rule 506, however, are much more promising. See SEC finally gets around to JOBS Act solicitation rules. Those changes will allow issuers to advertise and solicit IF all of the investors in the offering are accredited investors. Proposed regulations set forth some guidance on what will be required to satisfy the issuer’s obligation to verify that purchasers of the securities are accredited investors. Platforms are already tee’ d up to launch their companies into the spotlight as soon as the SEC finalizes regulations and says “go.” This is a giant step in the right direction but, again, it is not quite far enough. Companies have been soliciting accredited investors for years. If you don’t believe me, just go to one of the zillion pitch events that occur in my neighborhood each week. The real power in this is allowing professionals to go out and market private securities. The only thing they cannot do (unless they are registered broker dealers) is take success based fees.

And that brings me to the point of this section: the law should allow “finders” to take success based fees. The SEC has long viewed finders (i.e. those who “find” investors but do not broker the deals) as unregistered broker-dealers if they were paid based on funds raised. Case law has been more thoughtful, but with aggressive SEC enforcement (e.g. jail time) in recent years, the finder industry has basically been shut down. Big win for regulators – big loss for everyone else. The result of placing this artificial barrier between companies and investors is the new 506 exemption described above. While I think the new rules are just fine, sort of, and even kind of cute in a way, the law needs to go that one  extra step and let finders find and be paid for finding, even if it’s a success based fee.

A Million Other Things.

The List goes on. We have a long history in tax policy knowing what works and what does not. We have learned to see the value in technology and the danger in a government that wants to pick the winners and pardon the losers. We have data on what works in promoting international trade and what does not. Those topics are fodder for a future late night at the office and a later post. Stay tuned. UPKME3FP74ZA