How Tax Cuts Made Silicon Valley Possible

Release Date
August 2, 2017


Basic Economics

Tech inventors switched from making missile systems for the government to making personal computers thanks to tax cuts. Watch more with Dr. Domitrovic.

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Brian Domitrovic: We often hear that government created the internet. It’s funny what a myth that is, that government really had anything to do with creating the technological revolution. Now the real story is, is that when government was really involved in dominating the technological sector back in the 1950s, it wasn’t really producing anything for the American economy, but it’s when government decided to get a little smaller through the tax rate cuts of the 1960s. That’s when Silicon Valley took off. Let’s go back to the 1950s when you really start having the Valley under Frederick Terman, start to expand. You start to see lots of new companies coming in there. Today, we would call startups, they didn’t call them then, of engineers coming to San Jose, California to start making things. Virtually, all of these people were paid under government contracts so for example, Shockley Semiconductor, easily the most famous and important Silicon Valley company in the 1950s. They were mainly interested in producing guidance systems for the missile arrangements of the Defense Department and all sorts of government contracts.
What you don’t see in the 1950s and the early 1960s in Silicon Valley, you don’t see the development of personal products that are broadly useful, technological products, broadly useful to the American economy at large. You don’t see the personal computer revolution, all sorts of devices, all sorts of applications that people in the private sector can use. It almost exclusively is a phenomenon of government contracting. Well, what happens in the mid 1960s is that there’s a big tax cut. The tax rates go down at the top from 91% to 70% and at the bottom from 20% to 14%, and across the board, 30% tax cut comes in 1964. Do you know what else happens in 1964? The term venture capital is essentially coined. Venture capital is a term, that hadn’t existed before then, but it explodes in usage beginning in 1964. What does venture capital mean? Venture capital is when an investor decides to give a first investment to a guy with a really good idea that’s completely untested and the term basically didn’t exist before 1964.
Why? Well, when you have high tax rates, first of all, rich people don’t get to keep a lot of their marginal incomes. They aren’t able to accumulate the venture capital and then second, if this idea takes off and starts to make a lot of money, you don’t want the government to take all the proceeds in terms of the tax code. You want the tax code to take it easy in taking the amount of money that, that firm makes so it’s funny, right then in 1964, you see the explosion in the use of the term venture capital just as the tax cut comes in and that’s when you see the transformation of Silicon Valley. People who have left Shockley Semiconductor, most famously, Gordon Moore and Robert Noyce, start to think about how we can have more broadly marketable technological products and these two guys with a few others, most famously found Intel in 1968, which enables the personal computer revolution.
They said, “We’re going to kind of move away from making guidance systems for the Polaris missile and what we’re going to do is we’re going to embed computer chips into personal devices that can put computers on desks of everybody in the United States. That’s the inflection point when you start to see Silicon Valley move from just being the shop of the Defense Department and other places in the US government, to an economic engine that will become the economic grid of the United States in the year 2000 and beyond. It was the inflection point, was the tax rate cuts of 1964, which enabled the venture capital industry and that’s when Silicon Valley came into its own.