Ensuring Washington’s future business competitiveness

Ensuring Washington’s future business competitiveness
The legal challenge against Seattle’s progressive income tax has commenced, with investor managers, venture capitalists and former state officials involved. Aside from the tax’s unlikely survival, the legal fight symbolizes a greater effort to preserve Washington’s business competitiveness with other states for venture capital and the tech sector -- something that an income tax could easily undermine. Photo: VLAB.org.

Momentum is picking up against the city of Seattle’s progressive income tax as business leaders, former state officials and venture capitalists seek to insulate the area’s business climate against what national and local tax experts say is an illegal and unconstitutional ordinance.

The first lawsuit against the city was filed in July by Michael Kunath, the founding partner and principal of Kunath, Karren, Rinne Atkin LLC, a Seattle-based investment advisory firm. Seattle-based venture capitalist and Madrona Venture Group Managing Director Matt McIlwain has formed Opportunity For ALL, a nonprofit to fund the legal challenge.

This isn’t McIlwain’s first political foray into fighting a proposed tax. In 2010, he was behind the successful campaign against Initiative 1090, which would have imposed a statewide income tax on individuals with an annual income of $200,000 or more and $400,000 for couples filing jointly. It was overwhelming rejected by Washingtonians – and was the ninth time they’ve turned down an income tax.

The argument put forth by Seattle city councilmembers for a progressive income tax has been somewhat dualistic. Although touted as a way to address paying for local services, they’ve made no secret about their hopes that the State Supreme Court will use it as an opportunity to overturn 80 years of court rulings prohibiting a progressive income tax. Advocates claim that the state’s tax structure is regressive, and more of the burden should fall on high-income earners.

However, in an email to Lens, McIlwain wrote that this would be counterproductive to “a system that encourages job creation, economic opportunity and ongoing investment. Those elements have helped Seattle and Washington state increase tax revenues by $10 billion the past 6 years, invest in education at all levels and generate jobs at a rate that has produced the lowest (2.6%) unemployment rate in the history of the city.”

“Our view is that such a system is going to help all the citizens of Seattle best over time,” he added.

It was a point also noted recently on Twitter by Jeff Richard, managing partner at the California-based GGV Capital.

Also in agreement is the Washington State Department of Commerce. Its Choose Washington site brags that “we offer businesses some competitive advantages found in few other states. This includes no personal or corporate income tax.”

McIIwain has good reason to expect a return on investment for the nonprofit. Seattle’s income tax has been called illegal by tax experts at the Tax Foundation and former state Attorney General Rob McKenna, who is providing legal counsel to Opportunity For ALL.

Also among the group is Robert Mahon, a partner at Seattle law firm Perkins Coie and chair of the firm’s state and local tax practice. In a July 27 post, he said the city’s tax “raises significant legal issues and, in our view, is likely illegal under current Washington law.”

However, Kunath’s and McIIwain’s involvement symbolizes the concerns among the state’s venture capitalists and entrepreneurs that efforts such as Seattle’s could one day successfully undermine Washington’s business competitiveness. Tech investors have previously warned that a capital gains income tax could harm the state’s $37 billion information and communication technology industry and encourage many companies to leave. That would also have a compound effect on regional employment. For every tech job, another seven additional jobs are created, according to 2015 study by the Washington Technology Industry Association.

Whether implemented statewide or only in Seattle, a progressive income tax would also deny venture capitalists a critical advantage over other states such as California, which has individual and capital gains income tax. According to NerdWallet, “when combined with the top LTCG (long term capital gain) rate of 20% at the federal level, CA’s capital gains taxes are the 2nd highest in the world.”

However, what California loses in tax structure it makes up for with greater venture capital opportunities. According to the most recent MoneyTree Report by PricewaterhouseCoopers and the National Venture Capital Association, the Golden State ranked number one in the nation for venture deals during Q2 2017, with 469 deals raising $9.2 billion. In contrast, Washington ranked fifth, with 43 deals and $466 million raised.

Even without an income tax, Seattle has been described as a third-tier market for the startup sector by venture capitalist and Union Square Ventures Cofounder Fred Wilson.

He writes:

“This third tier is a decent place to be an entrepreneur and an investor. But there are challenges. Entrepreneurs in the third tier can access the talent and capital they need to be successful in these third tier markets but it is a bit harder to do both. Investors can be focused on these markets if they keep their fund sizes small enough or they can take a hybrid approach by being focused on these markets and also investing in the first and second tier markets.

“…. But there is a dynamic that goes on in these third tier markets where the local investors look to investors in the first and second tier markets to come down and “validate” their investments. And the investors in the first and second tier markets won’t come down and do that without a strong local lead. This game of “chicken” happens way too often in these markets and is incredibly frustrating to entrepreneurs in these markets. These third tier markets need a few strong Series A focused VC firms who have large enough fund sizes to be aggressive lead investors and also have the conviction and stomach to play that game.”

The lawsuit against Seattle may also been in part to send a clear message to other jurisdictions in the state that may contemplate similar proposals. Washington Policy Center’s Small Business Director Erin Shannon recently told Lens that “I like to call Seattle the ‘incubator of bad public policy,’” that can spread to other cities because “they see what’s happening in Seattle and they see no real disastrous impact. We’re not seeing business fleeing the city. Not yet.”

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