Beast Idea

Uncle Sam, Angel Investor: How an Equity Approach to Government Funding Could Revolutionize Revenue—Without Raising Taxes

Welcome to Tax Day. But with budget cuts and an aging population, it’s time to examine other models to raise revenue. So why not treat taxpayer investments into science and technology as equity?

Joe Raedle/Getty

When Holy Week ends, Tax Day descends. Lurking behind the scenes of Easter egg hunts and Passover dinners, you might have caught glimpses of wild-eyed accountants while citizens gripe and gulp before writing checks to the IRS.

This year, the underlying anxiety is supposed to be paired with the hope of tax reform, as congressional Republicans try to redeem their reputation for legislative competence by pivoting toward their core issue when they return from spring recess.

No specific plan has been presented and the chaos of the Republican caucus makes success murky at best. Nonetheless, there’s hope among policy wonks that tax simplification will finally take center stage. But in a pathetic abandonment of fiscal conservative principles, Trump’s OMB director Mick Mulvaney announced that deficit reduction is not a priority for this administration. In a double-insult to generational responsibility, the proposed Trump budget cuts much of the public investment that supports research in science and technology.

As America faces a future of budget cuts, an aging population and exploding deficits, it’s time for a more ambitious and innovative vision—moving beyond taxes to look for new forms of revenue that can spur long-term growth without saddling future generations with more debt.

So here’s a big idea worth exploring: What if the money given by state and federal governments to fund research and entrepreneurship was treated as an equity investment rather than a tax-payer funded gift or loan?

Treating Uncle Sam as an angel investor would not only incentivize R&D that can help keep our country economically competitive, it could provide dividends that stave off budget cuts and tax hikes alike. Future generations could be buoyed by an annuity created by today’s taxpayer investments. It might allow us to reduce the overall tax burden by providing an entirely new source of government revenue that’s built upon investment in the public good. That’s the definition of win-win.

This isn’t a pie-in-the sky idea or some sort of doomed-to-fail socialist scheme. It’s based on bedrock values and the venture-capital backbone of modern American investment.

The United States has been in the investment business since its inception. For over 200 years, the federal government has been a lending resource for farming, education and infrastructure (protected under Section 8 of the Constitution, “To promote the Progress of Science”).

Here’s how it currently works: The government gives out loans at low rates to encourage the kind of long-term national-interest investments (like railroads or steel) that no individual bank may want to fund. No matter how successful the railway or steel industries ever became, the American government would only make back its money plus interest.

But Silicon Valley runs on a much different type of investment, an equity model where venture capital firms hope to make (a lot) more money if the company does especially well. For example, an investor who had a $100,000 share of Apple’s 1980 IPO would have made $30 million by 2015.

As it happens, one of these early investors was the federal government, through the Small Business Administration—which takes credit for helping to fund the likes of Apple through a program that matches $2 for every $1 raised from private investors.

If the government had taken an equity stake in these initial investments, it would have made hundreds of millions or perhaps billions of dollars on behalf of taxpayers. (When we reached out to experts at the SBA who oversee these programs, it seems that no one has bothered to calculate what the government would have actually made if the funding was treated as equity.)

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But since the government doesn’t deal in equity, the treasury doesn’t benefit from a real return on its investment. And the government is never really incentivized to allocate more funding to science and technology because it doesn’t accurately track or recoup the costs.

Equity will never offset the need for taxes, but we could better align government spending in ways we know create long-term value.

It’s easy to anticipate the ideological criticism that if the government is treated like an investor, it will distort the free market by politically picking winners and losers. No one wants another Solyndra, the infamous titanic of an energy company that sank millions of dollars in government loans when it went bankrupt. But an equity model leverages the same “fund of funds” model that helped create Apple. The government just becomes one of many partners in institutions with an existing track record, mitigating the risk.

Many of the world’s most profitable internet companies started out at universities. For example, the founders of Google began as unappreciated graduate students at Stanford University, using National Science Foundation money to help to sustain their ramen noodle-fueled existence. Like most top universities, Stanford takes a cut of the intellectual property developed on their campuses and earned over $170 million when Google went public in 2004. Taxpayers got much less in direct benefit despite the fact that, in effect, they provided crucial seed capital.

Investments in university research sidesteps much of the “winners and losers” ethical thicket. Instead of taking intellectual property royalties, which can snuff out fragile startups before they generate meaningful cash flow, universities and the federal government can initiate their involvement as venture capitalists, funding businesses o based on academic origins.

This is what a new project at Cornell Tech is committed to creating. There is already legal precedent through the Small Business Administration’s Participating Securities program for the government to make indirect equity-style investments through venture funds. Rather than directly investing in Google, it’s one step removed by investing in funds that have a history of successful venture capital partnering with universities. This approach reduces the risk of political favoritism seeping into the process.

There are other exciting ideas brewing in this innovative space. The Small Business Innovation Act, being reintroduced this year by Senator Tammy Baldwin, would allow the government to recoup its investments through equity. “In order to build long-term economic growth, we need to make strong investments in advanced manufacturing, innovation, science, research and technology,” Senator Baldwin told The Daily Beast.

The approach could prove popular with Democrats and Republicans alike. The Defense Department keeps close tabs on its investments but it authored a glowing report of SBA loans for private contractors (PDF), estimating billions in new economic output and new groundbreaking innovations, including a laser-based LASIK eye procedure once used for Air Force pilots, now utilized in a significant portion of all consumer surgeries.

This plan could work for states as well as at the federal level. Residents of California, for example, could see long-term returns thanks to their $3 billion-dollar, ballot-approved, bond issue to fund stem-cell research. Lives have been saved thanks to the research, but as federal science funding dries up, scientists must convince voters of its value. Medical procedures built on the science could well pay for the bond over the long run, but with no objective way of measuring its benefits, these extraordinary discoveries are too often seen as a financial cost than an investment in the future.

Changing the federal revenue system to rely more on equity rather than simply taxes is a paradigm shift. But it has the potential to bridge partisan divides, incentivizing long-term growth while creating an intergenerational asset—an annuity that benefits tax-payers for generations to come. It’s a compelling vision for how we can all do well while pursuing the public good.