🏛️ From tariffs to income taxes: How history shaped your equity
San Francisco native (yes, really). @uw and Lowell High alum. I like to nerd out on fintech, stock options and taxes.
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San Francisco native (yes, really). @uw and Lowell High alum. I like to nerd out on fintech, stock options and taxes.
Vieje back here again. Happy belated tax day to all those who (hopefully don’t) celebrate
Besides the April 15th tax deadline, the news lately has been dominated by taxes, just in a different form called a tariff. Given the time of the year and the news headlines, I felt that it was appropriate that we focus this week’s newsletter on taxes.
For employees with stock options or equity in their startup, taxes are unfortunately a major factor in your take home when you can sell your shares. They could also be a major reason why you have not or cannot exercise your options. In fact, Secfi was started because our Founders were hit with a large tax bill at their last startup and had no way to pay it.
For today’s newsletter, I wanted to write a brief history on taxes in the United States given how everyone’s equity is impacted by taxes one way or another, and also touch upon the different kinds of tax like tariffs.
Perhaps one of the most impactful taxes in history was The Stamp Act passed by the British government on the colonies. The Stamp Act was a tax imposed on the colonies by the British government and ultimately became one of the reasons that sparked the Revolutionary War. “No Taxation without Representation” became a rallying cry for the colonists as they did not want to pay a tax where they had no representation in the government.
After the United States became a country, tariffs became the primary way for the government to raise funds. A tariff is a tax imposed by a government on imported goods from other countries. In short, the main system of taxation for the 1700-1800s was one where you paid a tax on any goods that you imported from a different country. If for example, you bought maple syrup from Canada to resell in the United States, you would have to pay a tax to the government to import that syrup.
The most common form of taxation - income taxes, did not become a normal thing for Americans until the 20th century. The first form of income taxes started during the Civil War when the government put together the first Federal income tax to fund the Union war effort. The tax was 3 or 5% of income. After the war, the income tax was repealed and the government went back to tariffs as a main form of taxation.
In 1913, the United States implemented a Federal income tax with the Revenue Act of 1913 leading to the 16th Amendment and our modern tax system was born. The introduction of income taxes started with rates of 1%-7% on income at the start and only less than 1% of Americans actually had to pay the tax at the beginning.
Unfortunately, the early 1900s was plagued by two World Wars and that meant that the government needed to fund the war effort. After the United States joined World War I, the highest tax rates quickly jumped to 67% in 1917. During the World War II years, the highest marginal tax rate jumped up to as high as 94%!
In regards to tariffs, they became largely unpopular in the 1930s due to the Smoot-Hawley Tariff Act. This act, which was implemented in the 1930s and raised tariff rates, led to a trade war, and many economists believe that it worsened the Great Depression. The post World War II years led to an expansion of global trade, and tariffs were no longer a central part of the United States tax system, instead turning towards income taxes.
In the remainder of the 1900s, Federal tax rates mostly dropped throughout the years. Years and years of politics did lead to a lot of tax loopholes over time, and in 1969, the first Alternative Minimum Tax (AMT) was implemented.
This is a newsletter for startup employees and we’d be remiss not to talk about AMT which may impact anyone who holds Incentive Stock Options (ISOs). The AMT was enacted in 1969 as some wealthy taxpayers became very good at finding loopholes in order to not pay any taxes. Naturally this angered the public and the politicians.
Instead of addressing the problems at hand which were the flawed tax system that opened the loopholes, Congress decided to add another parallel tax system called the AMT to ensure these wealthy taxpayers were paying taxes. Over the years, Congress saw Incentive Stock Options (ISOs) as a possible way for wealthy taxpayers to avoid paying taxes so they added ISOs in the AMT resulting in why a lot of you startup employees now get taxed to exercise something that you cannot typically sell due to private company restrictions.
That’s not the only tax that you’ll pay unfortunately. If you’re lucky to sell your startup equity at a gain, you’ll also likely trigger capital gains which is taxed at a preferential lower rate (20% at the Federal level). Capital gains rates were lowered below income tax levels in 1997 during the Clinton administration and then again in 2003 in the Bush administration with the idea that this would help the economy. In addition, Obamacare introduced a 3.8% net investment income tax on capital gains on high-income earners resulting in a total highest long-term capital gain rate of 23.8% that holds today.
In today’s political climate, we see a lot of talk about taxes, especially for the ultra-wealthy. The idea of a wealth tax has been thrown out there by some politicians which is effectively a tax on your net assets rather than assets sold or income earned. These come in many shapes or forms, but a form of wealth tax does exist today in countries like Spain and Switzerland. We do have a form of a wealth tax called property taxes here in the U.S. where you pay taxes on properties you own despite not selling them, but we seem to be a long way from implementing a true wealth tax.
Of course, the talk of the world right now is tariffs and the Trump administration has decided to raise tariffs on a lot of countries. In the modern world, tariffs have generally been used as a matter of trade policy rather than actually raising revenue for the government. For now, most of those raises are on a 90 day pause, but as of today’s writing, President Trump has thrown out a 245% retaliatory tariff on goods from China. Only time will tell where this tariff policy goes and the impact it will have on the economy and future taxation.
Okay, that is enough talk about taxes for the newsletter. Hopefully you were able to learn something and found it interesting. We’ll be back in two weeks, but as always, feel free to reach out if there’s anything we can help with.