Why Silicon Valley is furious over the GOP tax plan

The GOP is fixated on giving giant tax cuts to the uber-wealthy. But achieving that goal is making them some powerful enemies.

Both politics and legislative procedural hurdles demand a lot of offsetting tax revenue to make up for those tax cuts. So Republican lawmakers are aiming to cut deductions and tax breaks, among other changes. Sprinkling those tax hikes across American society was inevitably going to anger people. And now Republicans have infuriated Silicon Valley.

At issue is the fact that the Senate GOP's tax reform plan includes a provision that changes how stock option compensation is taxed. That proposal has sent Silicon Valley venture capitalists and tech industry lobbying groups into fits of apoplexy: "Universally terribly absolutely positively bad," "so ridiculous," "bad for innovation," "crippling," and so forth.

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When companies are getting off the ground, they aren't always able to pay employees high salaries right away. That can make it difficult to attract high-end talent. Meanwhile, established players in the tech sector — like Facebook, Apple, and Alphabet (which owns Google) — have huge cash reserves to cushion higher labor costs. So startups must find a way to compete for workers. They often do it with stock options: A new hire gets the opportunity to buy stock in the company at a special predetermined price. If the startup hits it big, that stock will soar in value, and the employee can then exercise their option and buy the stock at the much lower preset price. Voila: a big payday.

It's obviously a gamble, since most startups fail. But at its best, this practice can function as a way to get employees to do great work for a business in which they have a real stake, and profit mightily from it when the business succeeds.

As is, the federal government only taxes this sort of stock option compensation once it's exercised, as in, when the employee has bought the stock and sold it for a profit, creating an actual capital gain. But the Senate Republicans' tax reform bill contemplates taxing stock options once they vest instead.

This is a big change. A vested stock option may gain value on paper, but it can often be a real chore turning that value into actual money in your bank account that you can send to the IRS. Companies can and do impose rules and restrictions on how and when employees can buy and then sell their stock. There are practical hurdles, too: Even if a worker wants to exercise their stock options and then sell the assets off, they may not be able to find a buyer until the company has either been acquired or gone public.

“You can't spend it, you can't save it, you can't invest it. Because you don't have it yet,” as Fred Wilson, a managing partner at the venture capital firm Union Square Ventures, wrote in a blog post. But you're still being taxed on it under the GOP plan. This undermines the whole value of offering stock options to begin with, and throws a massive wrench into the tech sector's whole startup hiring and compensation model. "[I]t'll put a deep freeze on recruitment of the best talent into high-growth, innovative industries," said Leigh Drogen, the founder and CEO of Estimize. "There's no way you could hire the best talent to a startup or high-growth company."

In all likelihood the Senate will ultimately kill this proposal. The National Venture Capital Association is already pressuring Senate Republicans to do so, and was successful in getting the House GOP to roll back a similar provision. And it's not like the GOP desperately needs this rule. The 10-year increase in tax revenues from this change is estimated to be $13.4 billion, a relatively paltry sum compared to the several trillion in revenue losses the GOP is trying to offset.

But could a rule like this actually do some good?

Silicon Valley is draconian when it comes to restricting how its employees can exercise their stock options. Taxing stock options when they vest could force companies to make rules that are a lot simpler and cleaner: Just give employees the green light to do whatever they want with their options once they've vested, and leave it at that. If you tax stock options earlier, it stands to reason that employees will need more freedom to do with those options what they wish, when they wish.

There are other potentials good here, too. Maybe firms would move away from stock options and toward more straightforward profit sharing, in which employees have set salaries, but get big bonuses when the company profits. This wouldn't work with every Silicon Valley company — many of the most successful, like Amazon and Netflix, are famously not profitable, despite enormous valuations. But it could still incentivize employees to care about and personally invest in the long-term health and performance of the company.

The problem, of course, is that we live in an economy where company performance is entirely subservient to Wall Street's demands for massive shareholder payouts. And Silicon Valley is no exception. Something like profit sharing, by definition, eats into the profits that provide those payouts. Indeed, the whole goal of keeping profit margins high is somewhat in tension with the goal of hiring and retaining good talent, since shareholders and workers are in competition over the same revenues. The rise of stock options was a way for Silicon Valley to have its cake and eat it too. And now, it's under threat.