Needed: A Tax Cut that Helps Small Tech Firms Bounce Back

President Bush’s tax-cut proposal is commendable. But at the threat of finding a cloud in its silver lining, it misses one key ingredient: reform aimed at spurring growth where it is most lacking ? in small business, particularly technology business.

This sector of our economy, so well represented in the Northwest, has proven critically important in spearheading past economic recoveries. It will do so again, given the capital to fuel it.

To do so, the president and Congress should raise the income-tax deduction on capital losses from $3,000 a year, as it currently stands, to $100,000, so long as the additional amount deducted from income is reinvested in a qualifying small business within the same calendar year.

This proposal is not to be confused with unconditional increases in the capital-loss deductions against ordinary income, amounting to partial loss “refunds,” as proposed at the president’s economic summit in Waco, Texas.

It also differs from Democratic “targeted tax cuts” in that it does not specify where the money must be invested, only in the size of the business (using the 1997 Taxpayers Relief Act as a guideline, a small business would be defined as one with less than $50 million in assets).

Instead of getting something for nothing, the increased capital-loss deduction kicks in only after making an additional investment in small business ? following which the long-term benefits measured by new companies created and strengthened could be enormous.

This is why. Corporate megaliths notwithstanding, small business is the vital engine of economic growth. It creates more than two-thirds of new jobs nationwide and generates more than half of our country’s gross domestic product.

At the moment, big businesses ? all of which were once small ? are going through deep layoffs, with no apparent short-term plans for rehire. We have felt this pain acutely in the Northwest in the case of Boeing, Weyerhaeuser and others. In the past, small business has picked up the slack, but recent data suggest that is not the case today.

According to the Money Tree Venture Capital Survey, in the third quarter of 2002, venture-capital investment plummeted to a mere $4.5 billion nationwide. This figure is down 25 percent from the previous quarter, and more than 85 percent from the survey’s peak of $29.1 billion in the second quarter of 2000. Current venture funding now stands at its lowest level since 1994.

Many of those who have lost money investing in businesses now sit on the sidelines, heeding the advice of pundits who push the safety of cash over reinvesting. This trepidation especially affects small businesses that depend on thousands of individual decisions by willing investors to start and grow new enterprises. Many of these silent “angels” of the economy are tapped out, or have been made so risk-averse by the current economic environment that they are now choosing to sit on their hands.

This plan could free up billions. Further, data from our experience at Madrona Venture Group show that about 70 percent of this money would go to small-business salaries and wages ? and be taxed by the IRS at an aggregate level greater than the benefit received by the investor ? making this proposal revenue-neutral (no net loss to the government), or even revenue-enhancing, in short order.

And to the extent that the investment fuels the economy’s driving sectors, especially high-tech, we become more competitive in world markets through increased productivity.

Entrepreneurs have not gone away, but their primary source of capital has all but dried up. Investors need a tax environment that encourages them to get back into the game. Bush’s plan is a step in the right direction.

Added to his plan, this capital-loss-deduction proposal would represent a giant leap forward toward reigniting the struggling tech economy. It would help resupply the cutting edge of the economy with the ready capital it requires to innovate and thrive, helping accelerate it to unprecedented levels of growth and productivity.