SPUR to SF Supervisors: Don't Let the Next Google Get Away

BY GABRIEL METCALF AND JENNIFER WARBURG
April 4, 2011
Three big start-ups may leave SF over the payroll tax.

While the Bay Area is still climbing out of the great recession, we’re simultaneously experiencing the makings of a second dot-com boom. The Chronicle reports that tech jobs have climbed near to their year 2000 peak of 34,116. Silicon Valley is hiring again. And so is San Francisco. Between Twitter, Zynga, Yelp, Salesforce and others in social media, gaming and cloud computing, a growing sector of the economy is based right here in the city.

We can’t predict in advance which companies will succeed: Google launched during the last boom, but so did Webvan, whose only traces today are the eponymous cup holders at AT&T Park. Nevertheless, it’s encouraging for all of us who promote economic development to see this kind of growth and investment in a niche well-suited to our city.

The question is, will San Francisco be able to retain the successful companies as they grow and begin to employ significant numbers of people?

Right now, the answer is a frustrating no for one very clear reason. Our payroll tax.

San Francisco has a relatively unique business tax that requires companies with payrolls over $250,000 to pay the city the equivalent of 1.5 percent of total employee compensation. SPUR has argued for years that we should restructure the city’s tax system to remove this disincentive to hiring, replacing the payroll tax with either a gross receipts tax or, better yet, a tax on behavior we want to discourage, like pollution. In the last decade, SPUR has served on several major revenue panels that tried to eliminate the payroll tax, only to founder on the problem of political opposition to the alternative taxes.

Recently, we’ve come to understand a particularly harmful dimension of the existing payroll tax: its levy on stock options.

San Francisco is the only city in California that charges a payroll tax, and it may be the only city in the country that extends this tax to stock options. Thanks to Sarah Lacy of Tech Crunch, who broke the story, a new report from San Francisco’s chief economist and some excellent reporting by the Bay Guardian, the particular problem of taxing stock options has become clear. San Francisco forces companies to pay the payroll tax when employees exercise their stock options — a strong incentive for a company considering an IPO to get out of the city.

This is a particular problem for fast-growing tech companies, a sector that has shown notable promise for the city. The levy has generated a flurry of discussion and concern from pre-IPO companies who stand to lose millions of dollars if they stay in San Francisco.

The last time the city leadership did something about the payroll tax, it was a measure targeted to draw biotech firms into the city. In 2004 San Francisco adopted a biotech tax credit as part of a coordinated strategy that included building Mission Bay; locating a new UCSF campus there; zoning for biotech space; and attracting the California Institute for Regenerative Medicine to San Francisco. The tax credit exempted the companies from the 1.5 percent pay roll tax for 7.5 years — and it’s clear that, as part of a broader economic-development strategy, it had a huge impact. The number of biotech companies locating jobs in the city has gone from two to 74.

The biotech tax credit involved targeting a specific industry; this year the city proposed targeting a specific geography with the Mid-Market tax credit put forward by Supervisor Chiu. SPUR has been very supportive of this measure. While we retain skepticism about the effectiveness of tax breaks in general, there is a strong policy rationale for trying out such a strategy in Mid-Market, a stretch of blocks that has resisted attempts at economic revival for decades.

Spurring the conversation this time is Twitter’s possible move to Brisbane. For SPUR, the issue isn’t retaining the social-media giant — although it would be a significant win for the city. It’s never a good idea to engineer tax breaks for individual firms. But an incentive for any company to create jobs in struggling Mid-Market is an idea with strong policy merits.

The conversation that started with Mid-Market and attempts to keep Twitter in San Francisco has now expanded to encompass strategic thinking about the wider tech community. We have a pivotal opportunity to keep a piece of this industry in the city instead of watching all of it move to the suburbs. Right now Twitter, Zynga and Yelp are making decisions about whether to stay in San Francisco. But we need to fix the tax structure for all the firms we don’t know about yet.

The good news is, there’s a lot of interest across the political spectrum in dealing with the problem:

• Last week, Supervisor Mirkarimi introduced legislation to exempt all companies in San Francisco from paying payroll tax on stock options for two years.

• Supervisor Farrell, who has worked in venture capital and knows this issue well from the private-sector side, is working on a permanent way to take stock options out of the payroll tax.

• Supervisor Chiu is rumored to be getting ready to take another run at getting rid of the payroll tax entirely and replace it with other revenue sources.

For the most part, these ideas are not in conflict. In fact, we may need all of them. We need to do some more intense geographic targeting of incentives for Mid-Market. We need to give immediate assurances to tech firms who will otherwise need to leave the city in the next few months. And we need to revise our tax code for the long haul to not tax stock-based compensation.

Keep in mind that if we do all of this, the city will still come out ahead fiscally. We will have more jobs, and firms in all parts of the city except Mid-Market will still be paying payroll tax on the salaries of their employees.

City supervisors will vote on the Mid-Market payroll tax tomorrow, April 5. To them, SPUR says: vote yes. But don’t stop there. Move quickly to restructure the tax code so that we can retain more of the tech firms that have taken root in San Francisco.

If we get this right, we will be able to get out of the murky business of “tax breaks” for specific firms or locations. What we will have instead is a tax structure that makes it possible for dynamic firms to add jobs in the city while funding local government in a way that supports high levels of public service.

While most of the country is scrambling to identify a future economic base, San Francisco has the good fortune to host a whole ecosystem of dynamic, cutting-edge companies that are a good fit for the quirky progressivism and creativity of this place. If we get barriers out of the way and make it possible for fast-growing tech companies to stay, we may find a way to put people to work and fund public services at the same time.