Income Taxation of Founders’ Stock: A Really Dumb Idea

Last year when there was a big debate about carry taxation, I came out in support of taxing carry as income (even though that will clearly mean a much higher tax bill for me personally).  With the budget battle in Washington reaching ever new heights this issue is coming back in full force.  I missed Nic Kristof’s column on this last week.  I am completely in agreement until he gets to the point about taxing founders:

One important proposal has to do with founder’s stock, the shares people own in companies they found. Professor Fleischer has written an interesting paper persuasively arguing that founder’s stock is hugely undertaxed. It, too, is essentially a return on labor, not capital, and shouldn’t benefit from the low capital gains rate.

The Professor Fleischer quoted here is a law professor at the University of Colorado who has apparently not spent a lot of time with entrepreneurs. To characterize their gains as a “return on labor” is completely misguided.  In reality this is a “return on passion, ingenuity and creativity” and it should be taxed at *less* than capital gains from trading!

Why?  Because we desperately need more of it.  Employment is created by new companies in new industries.  Taxes are all about influencing incentives and if anything given the terrible employment numbers we want to tilt incentives dramatically towards starting new companies.

Founders Stock