Actually I've never said that startups do better in SF specifically, but rather the Bay Area. This problem is limited to the city.

The difference between the two cases is that the employees are being taxed out of money they have (if they exercise and sell) whereas the company is being taxed based not on revenues but on the appreciation of its stock. So a company whose valuation shot up in advance of anticipated revenues could find itself with a bill it had no money to pay.

The tax bill your hypothetical company faces will be based on options that are actually exercised. Except for an incredibly fortunate few early employees, I'd wager the vast majority of options have a strike price something higher than 1.5% current valuation ... and, viola, there's your cash to pay the bill, perfectly timed. Crisis averted!

More generally, a company whose valuation shoots up but which is unable to find cash to meet shorter-term needs is Doing It Wrong and doesn't deserve the higher valuation.

Musing about this tax in general, without specifically debating:

I think payroll taxes of any form are one of the worst kinds of tax, so from that point of view we can agree. (Somehow I don't think you'd agree that significant increases on taxes for the wealthiest are a better alternative, though.)

But, if you're going to tax wage and salary compensation, then it's more than fair to tax options and other forms of compensation, too -- otherwise you end up with a regressive payroll tax, which punishes poorer workers & companies at the same time as being far less efficient at raising the needed revenue.

(edit: Part of my post was in response to something I hadn't noticed you'd edited out, so I snipped it belatedly.)

Ah, OK, now I understand a problem I can agree with - so it's not so much the damage from paying 1.5% on a profitable transaction (employees exercise options as part of winning start-up lottery) but rather the company has to pay cash for a gain it only realised in paper. So now I understand why they were saying a company going for IPO would have to pay most of the money raised as taxes, rather than just 1.5% of it.

Why is no one suggesting applying the 1.5% when cash exchanges hands? Everyone is either suggesting keeping the 1.5% as is, or scrapping it completely for stock options. But surely a middle ground allows cash for taxes as a small percentage of cash from profits?

I'm not sure I follow your post; apologies if it's my own up-too-late-itis. "When cash exchanges hands" is when the tax does apply, assuming by that you mean options being exercised.

That's why in my imaginary example a post or two ago, one of the more fantastical & unlikely parts of it was a full 30% option pool all being exercised at once.

Hence, (and I apologize for any inaccuracies in paraphrase) the post you are replying to is recasting the tax as a potential cash-flow issue, rather than a great and unfair ongoing burden: because it's not.

My understanding was the same as yours above, but it seems that if there is a valuation event – an IPO, for example – then the rise in value of all shares is counted, not just the ones which were sold.

Separately, I do not think the tax is unfair. Tax has to come from somewhere, and if SF can show a nicer environment for employees and founders to live in, then they can charge a higher price for the environment. Tax competition takes care of testing whether this is a wise decision, and there is plenty of tax competition in the region surrounding SF.

To me, tax becomes unfair if it is arbitrarily applied to some people, but not to others, e.g. letting Twitter and Zynga off, while taxing other start-ups.

> My understanding was the same as yours above, but it seems that if there is a valuation event – an IPO, for example – then the rise in value of all shares is counted, not just the ones which were sold.

Well, that would explain a bit of the whining, but I will need a nice solid citation before I believe a word of it.

First, because I cannot fathom how it could possibly work: What's a qualifying "valuation event"? What if another event comes along and the valuation has dropped -- is the company entitled to a refund, then?

Second, because that would be the only tax scheme I've ever heard of, except maybe some proposed & hair-brained wealth taxes, that directly taxes unrealized gains. (Wealth taxes I'm aware of that actually exist tax unrealized gains under simple growth assumptions, not based on any sort of actual valuation.)

Third, because if that were the case you'd think that the vocal opposition would be able to articulate it more clearly.

> To me, tax becomes unfair if it is arbitrarily applied to some people, but not to others, e.g. letting Twitter and Zynga off, while taxing other start-ups.

Exactly the problem that the options tax was introduced to solve, as well. If there is a tax on employee compensation, why shouldn't the executive compensation of $1 salary + $300 million in options be taxed at the same effective rate as the janitor's wages?

(N.b.: I think a payroll tax is dumb, but a regressive payroll tax is dumber!)

(Edited a bit for clarity & removed a side comment.)