Why Obama Should Lower Capital Gains Taxes for VC's

First of all, I voted for Obama, but I believe he is completely off target on capital gains tax, because of the negative effect it has on innovation, job creation, and the proper multiplier effect.

Capital gains taxes should be lowered across the board to encourage investment in equities, since these companies can create more jobs in a healthy stock environment and have more money to invest in new developments. In turn, the resultant bump this will give to equities will generate more revenues (wealth creation) for individuals and corporations, and, in turn, for the government from increased capital gains and corporate tax receipts. Why doesn't Obama get this?

Certainly, government coffers are lower now, because of the stock market crash. Stimulating investments in stocks through a capital gains reduction will create massive revenues for the government, reduce the need for other tax increases, build consumer confidence, and get people spending again. That's how jobs are created. The primary reason the Clinton administration had a budget surplus was due to a robust stock market during most of his tenure. Reducing capital gains will help insure a return to this form of prosperity.

More importantly, there should be a moratorium or elimination of capital gains taxes on income derived from investing in venture capital. Why? Venture capital is the riskiest capital there is. It should be rewarded for this risk, yet it is treated the same as public equity. Traditionally, it invests in the most innovative, risky technologies. Today, it is so hard for VC's to raise money, they are investing more and more in later stage companies and staying away from true innovation. Without innovation, this country becomes an also ran, which is basically what eight years of Bush has made us.

VC's deserve a bigger cut in capital gains tax, because it takes years to obtain a return on investment. Furthermore, we need VC to get back to fueling innovation, something on which the US economy is dependent for its future well being. China and India are graduating a multiple of the engineers in every discipline than we are in the US. Their VC industry is not as developed as in the US, but ironically, more and more US VC dollars are being invested in these countries, because of the low cost of labor. Furthermore, many of these nations have no capital gains tax. This means innovation is beginning to become far less an advantage of the US, and it is essentially getting exported along with our manufacturing jobs.

We are losing and will continue to lose manufacturing jobs and venture capital investment dollars to nations with a lower cost of labor. In just the year 2007, Ohio lost 25% of its manufacturing jobs, mostly due to lower cost overseas producers. Read that last sentence again. It's astounding. Putting up trade barriers is just plain idiotic. It will only cause our consumers to pay more for everything. 

What will replace these lost jobs? We have an 8.6% unemployment rate in the US, and it's rising. Obama's plan of spending money will temporarily stimulate the economy and create some jobs, but most of these stimulus dollars have a low multiplier effect. Innovation has a far high multiplier effect. Government spending has the lowest multiplier effect of any form of spending in our economy, and of government spending, military spending has the lowest multiplier effect of all. Obama's plan is not a long term solution to our country's need. On capital gains, Obama completely misses the point. When he first started campaigning, he wanted to increase capital gains from 18% to 30%. Advisors (probably Warren Buffett) talked him down to 20%, but this is still in the wrong direction. It should be noted that Buffett makes few, if any, investments in innovation.

This country desperately needs to retrain its work force for jobs of the future. These jobs will come primarily from IT, biotech and other life sciences, and new forms of energy. 

Take healthcare, for example. Baby boomers are entering their disease prone years, so they will need much more healthcare in the years to come. Healthcare, as a percentage of GDP, is expected to rise from 16-17% today to nearly 20% of GDP by 2017. That's one out of every five dollars, and the rise as a percentage of GDP for healthcare is unlikely to stop there. People are living longer, and they will need more care for decades to come.

That will create a lot of jobs, but we do not have enough doctors and nurses today. We need to concentrate on why this is and fix it. Besides, doctors and nurses are jobs that cannot be exported due to cheaper labor, unless a patient is willing to travel abroad for less expensive operations. This traveling abroad for operations, by the way, is happening more and more as our cost of health care rises. Unfortunately, all too often, people are getting what they pay for when they do this. I know one lady who went to India for a colon cancer operation, and they did not even save a piece of her cancer to make a personalized vaccine to help her boost the antibodies in her system against the cancer, something that more and more major cancer centers are doing in the US. 

One big source of our health care cost rise is our archaic legal system, which encourages malpractice suits, even when there has been no malpractice - more on that in another blog. As a result, fewer people want to become doctors, or they are leaving the profession altogether, because they cannot afford the malpractice insurance. Even if they can afford the insurance, this cost must be passed onto the patient, further driving up healthcare costs. 

But the biggest reason for the increase in our cost of healthcare is we are not investing enough in new technologies and therapeutics that can reduce the cost of our healthcare. These technologies exist, yet there is little money to fund them. Great companies with life saving, life extending and cost saving technologies are going bankrupt everyday, because there is not enough venture capital to advance these companies. This means there is not enough money to advance the creation of the types of jobs that can backfill the loss of traditional manufacturing jobs to overseas companies. Also, new medical technologies would create a whole new class of manufacturing jobs. This requires us to educate and retrain our workforce for this new economy. Fortunately, Obama gets this part of the equation.

Unfortunately, today venture capital companies are having great difficulty raising funds, since many of the endowments, fund of funds, and state pension funds that feed their coffers have reduced their allotments to VC, due to heavy losses sustained in the equities portion of their portfolios. As a result, this nation is investing a much smaller amount into innovation than it was a just a couple years ago. 

Yes, it is promising that the Obama administration has boosted NIH spending by $10B, but NIH grants are usually quite small and are not nearly enough to make up for the great shortfall in venture capital. In 2008, there was roughly $29B spent by the NIH on 46,000 grants, which means the average grant was $630,000. This spurns a lot of fundamental research, which is great, but it is not enough money to bring these great discoveries to market.  Bringing new cancer therapies and vaccines to market can cost tens and hundreds of millions of dollars, and much of this money must come from venture capital, since big pharma is mostly interested in products showing success in Phase III trials. NIH dollars are not nearly large enough to fund the vast majority of clinical trials.

This shortage of capital creates another problem. It forces VC's to invest in what can get to the market the fastest, not necessarily the best solutions. For instance, billions have been invested in small molecule drugs, one because they can get to the market more quickly, and two because big pharma likes to sell pills that you need to take every day for a long time, regardless of the side effects. Biologics, on the other hand, can be more expensive in the short run to develop, but they are often a more effective therapeutic, with fewer side effects, if any, and they are less expensive overall as a therapeutic. However, for big pharma biologics are a nightmare, since they cannot realize the same margins on products that work better, faster and cheaper. This will change, because either they will get funded in this country or abroad. Better always wins out in the end. Companies like Roche get this, which is why they bought Genentech.

The future cannot be avoided forever. The evidence of this is that for the last few years, the FDA has started to approve more biologics for the market than drugs for the first time in history. However, with the present shortage of VC dollars, this trend to better healthcare is threatened. 

Because the primary sources of venture capital have dried up, reducing or eliminating capital gains tax for VC's will help this country promote the level of innovation necessary to make it more competitive. We are a debtor nation that imports far more than we export. Without proper incentives to invest in innovation, that will only continue. 

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