The Problem With Georgia HB 1069 (Part 1)

In case you didn't notice, Georgia HB 1069 passed and was signed into law last week. A lot of people were happy with this but I had more of a blasé feeling about it. There are a few reasons for this and I thought this would make the perfect kick off for starting to write about public policy.

My Bias

First I want to make sure I make my own bias clear. I'm an entrepreneur. I've launched one company that was later acquired and recently joined another that's just starting up. I'm also an angel investor both individually and through Shotput Ventures.

From both of those standpoints I should be a proponent for the angel tax credit. More money into startups would mean an easier time for me as an entrepreneur and a tax credit means my risk exposure is reduced as an angel.

That said, I've never let my own economic desires stand in the way of what I thought was right. Also please recognize that nothing I say in this post (or really, ever) is sanctioned or endorsed by any place that I am affiliated with. In fact, most organizations should disavow anything and everything I say. At least, I would if I were them. Comes with the territory I suppose.

Startups Subsidized by the Poor

My first issue with HB 1069 is how the angel tax credit is (apparently?) paid for. Along with the angel tax credit, the bill also creates a tax credit for buying more energy efficient products. Personally, I think this is a great thing. The less energy we use means the less energy we have to import and the less we pollute our environment. No complaints so far especially since this tax credit is paid for by federal funding.

But the bill also removes a tax credit for low income individuals. Granted the amount per citizen is low (maximum of $52 per year), this removal saves the state $21 million per year which is then partially used to pay for the angel tax credit which will cost $10 million per year. Where does the other $11 million go? Good question - I have no idea.

Now, I'm all for increasing angel investments in Georgia. But personally I don't want that to come on the backs of the most needy citizens in our state. Some have argued with me that by increasing angel investments in Georgia will mean for a better economy and these individuals will benefit. Sure, that may be true in the long run but how are these folks going to pay for their needs today?

Comparison to Other States

There was a common comparison made during the discussion of this bill that twenty-one other states had enacted angel investment tax credit legislation. First let me point out the obvious that 21 out of 50 states is not a majority. But that's okay, there are more issues with this argument.

Looking at the Angel Capital Association's list of states with an angel tax credit, you'll see that half of the twenty-one states (Minnesota has a tax credit both above and below Georgia's tax credit amount so they count twice), have tax credits at a rate less than what was just passed in Georgia. Also notable is that Hawai'i has a tax credit of 100%. That's some good living there, beaches and a 100% tax credit. But I digress..

The most interesting thing about this list though is not the amount being given by each of the states. What I find most interesting are the states not on the list. Any idea what the tax credit rate is in California? That would be none. What about Massachusetts? Again, none. Okay, well there has to be one in Washington, right? Nope, no tax credit there either.

Three states that are among the most prolific in creating and funding startups have no need to have an angel tax credit. So are we focused on the wrong thing here? Perhaps. Let's take a look at the numbers.

The Financial Breakdown

The financial aspect of HB 1069 is perhaps the part that I find most disturbing. Let's get into the nitty gritty.

First, the bill provides for an aggregate allotment of $10 million annual tax credit for investments made in 2011, 2012, and 2013. That means $30 million in tax credits. From an angel perspective there is one painful wrinkle here. For investments made in each of these years, the credits cannot be claimed until two tax years later (so investments in 2011 can be claimed in the tax return for 2013 but really that means the 2014 calendar year). This was a smart move by the state of Georgia because the tax credits are deferred up to three years into the future.

The bill gives an individual angel a 35% tax credit of no more than $50,000 total in a single tax year. So that means we would need at least 200 angels each year investing $142,857 to fully use up the credit. Obviously if more angels take the credit, there would need to be a lower average amount invested.To use the entire $10 million tax credit then would require an annual angel investment of about $28.57 million each year.

For each angel investor that takes this tax credit, their tax basis for their stock is reduced by the amount of their tax credit. This makes perfect sense.If you take a tax credit of $50,000 that means your cost basis for your stock goes down by $50,000 so that the state can receive tax revenue when you successfully sell your shares in the startup.Herein lies the problem.

Doing the math on the $10 million credit implies that $28,571,428.57 worth of angel investments were made. These investments then have a cost basis of $18,571,428.57. Assuming a top Georgia tax rate of 6% (this is the optimistic view, by the way), means that to recoup the initial $10 million tax credit would require these investments to gain $166,666,666 in value. Or said another way, these investments would need to, on average, return 6.48 times their original investment amount.

Sure, 6.48 times an investment may not sound too difficult but the Kauffman Foundation reports that experienced angel groups achieve returns, on average, in 3.5 years and receive 2.6 times their investment. So the state of Georgia needs angel investors getting the tax credit to achieve almost 2.5 times the returns experienced on average by other investors. We may think people in Georgia are smarter than average but they aren't that much smarter than average.

Note: I do recognize that I'm not taking into account any effects of income taxes, etc. into this break-even analysis but I did use an optimistic view when I could.

What this means is that the angel tax credit is a big tax subsidy. There is little to no chance that we'll recoup our initial investment. So to me, the angel tax credit is akin to welfare. Do individuals who are doing angel investing need to be on welfare?

In Closing

I know I haven't provided my solution to this issue quite yet. This post is quite long and so I thought I'd leave that for next time. In the mean time I'd love to hear from you why you do or don't like this bill (or this blog post) and what, if anything, you would change (in this post or in the bill).

Postscript

Part two of this discussion is available here.