Dear Reader

I’ve talked about California’s proposed billionaire wealth tax before.

It’s heading to voters this November as Proposition 40.

The basic idea is that Californians worth more than $1 billion would owe a one-time tax of as much as 5% of their net worth.

The last time I talked about this, I focused mainly on the slippery slope.

Because whenever politicians introduce a new tax, they always start with somebody rich enough that almost nobody feels sorry for them.

Don’t worry. It’s only billionaires (don’t be a bootlicker!)

Then the threshold comes down. The rate goes up.

And years later, a tax that was never supposed to affect you suddenly does.

But today I want to completely set that argument aside.

Let’s assume the politicians keep their word.

Let’s assume this really is a one-time tax.

Let’s assume it never spreads beyond billionaires.

It still makes very little economic sense.

And Congressman Ro Khanna has inadvertently given us a pretty good demonstration of why.

Khanna represents Silicon Valley and has become one of Proposition 40’s most vocal supporters.

But recently, Mark Cuban pointed out a pretty basic problem with the tax.

A lot of startup founders who are worth billions aren’t sitting on mountains of cash.

Their wealth is tied up in shares of the company they built.

Now, you probably already know this.

A funding round values the company at $10 billion and suddenly a founder can technically be worth several billion dollars.

That does not mean they have several billion dollars in their checking account.

So Cuban asked Khanna a pretty simple question:

How is this founder supposed to come up with hundreds of millions of dollars to pay a wealth tax?

And this is where things get incredibly stupid.

Because Khanna’s solution was to:

Borrow From the Government…to Pay the Government?

Khanna suggested that an illiquid founder could pledge shares of his company to the state.

The state would then lend him the money he needs to pay the wealth tax.

In other words, he’s proposing that the government would lend the founder money…

And that founder would immediately hand that money back to the government.

Khanna suggested the loan could last something like ten years.

Eventually, the founder would either repay the loan in cash…

Or the government could take the pledged shares.

Cuban called that solution “insane”.

And then he asked the question that immediately came to my mind too:

“What’s the point of that?”

If California has to create a loan so the taxpayer can pay California…

What exactly have we accomplished?

The state has created a tax liability.

Then it has created a financing program to solve the liquidity problem caused by the tax liability.

And if the founder cannot repay later, California could eventually wind up owning part of the company.

Cuban joked that the other investors would surely be thrilled to discover the government was their new partner.

Bill Ackman then pointed out another problem.

Imagine the founder takes Khanna’s government loan, pledging his shares as collateral, and uses the money to pay the wealth tax.

Then the company fails. The shares go to zero.

At that point, the government may have to forgive the loan because the collateral is worthless.

But forgiven debt can itself be treated as taxable income.

So now the founder has lost the company, lost the value of his shares…

And could still be left with another tax bill because the government forgave the loan it gave him to pay the first tax.

Where is the founder supposed to find the cash to pay that tax after his company has already failed?

Khanna’s response was simply “That’s a real issue”...

Which, to me, is a clear acknowledgement as to just how little thought he’s put into it.

And Cuban and Ackman aren’t the only ones ridiculing Khanna’s proposal.

Palmer Luckey, who founded Oculus and later co-founded Anduril, described Khanna’s idea as putting founders on a ten-year “speedrun”...

Warning that this kind of policy pushes companies toward short-term profit at the expense of long-term value creation.

Andreessen Horowitz co-founder Ben Horowitz joked that if your goal were to destroy Silicon Valley’s extraordinary network effect, this tax was the “best strategy” he had seen.

Reddit co-founder Alexis Ohanian called the proposal “objectively broken” and said it made Democrats look “financially illiterate.”

Y Combinator CEO Garry Tan warned that it could “kill and eat the golden goose of technology startups in California.”

Now, you can dismiss all of these people by saying:

Of course rich people don’t want to pay more tax.

But that misses the broader economic issue.

The question isn’t whether Mark Cuban or Palmer Luckey can survive being slightly less rich. Of course they can.

The question is…

What Happens to the Incentives That Created All That Wealth in the First Place?

This is where wealth-tax arguments get distorted.

Politicians look at somebody who owns billions of dollars of founder stock after the company succeeds.

At that point, the wealth looks inevitable.

But it wasn’t.

The founder could have spent ten years working on something that went nowhere.

Investors could have lost everything they put in.

Employees could have accepted lower salaries in exchange for equity that eventually became worthless.

That happens all the time.

CB Insights studied more than 1,100 startups that raised seed funding and found that only 1.28% eventually became unicorns – aka achieving the coveted billion-dollar valuation.

That means almost 99 in a 100 startups never get there.

Not to mention, even getting to a $1 billion valuation is no guarantee that a company will become one of those giant winners.

McKinsey looked at more than 2,700 founder-led companies that had reached that stage and found that only about 10% of those went on to reach a $10 billion valuation.

So by the time you’re looking at a founder whose company is worth $10 billion, you’re looking at the survivor of a process where the overwhelming majority of outcomes were far worse.

All the companies that failed along the way have mostly disappeared from view.

The giant winner left standing is the one everybody can see.

And then politicians look at that founder’s stake as though the billions were sitting there waiting for them from day one.

But those billions only exist because somebody was willing to take a huge risk years earlier.

The founder took it. The investors took it. The employees often took some of it too.

And the reason people accept those risks is because the payoff, in the rare case where everything works, can be enormous.

That’s the incentive.

A wealth tax doesn’t just take money from somebody after they get rich…

It Changes the Potential Reward Before the Next Founder Ever Starts the Company

Maybe they build somewhere else.

Maybe investors steer their money toward companies based in states with friendlier rules.

California became enormously wealthy by attracting people willing to make long-shot bets with enormous upside.

Proposition 40 looks at the winners of that system and says the payoff is too large.

But if you keep reducing the payoff for winning…

Eventually, you get fewer people willing to take the risk of losing.