Silicon Valley Exists Thanks to Tax Cuts

Silicon Valley started out making guidance systems for missiles for the Defense Department.

We often hear that government created the internet. It's funny what a myth that is, that government had anything to do with creating the technological revolution. Now the real story 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. It's when government decided to get a little smaller through the tax rate cuts of the 1960s that Silicon Valley took off.

Going Back to the Start

Silicon Valley started out making guidance systems for missiles for the Defense Department.Let's go back to the 1950s, when you really start seeing the Valley begin to expand under Frederick Terman. You start to see lots of new companies coming in there. What we would call startups today – but they didn't call them that then – of engineers came to San Jose, California to start making things. Virtually all of these people were paid under government contracts – 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 is the development of personal products that are technological products that are 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? There's a big tax cut. The tax rates go down at the top from 91 percent to 70 percent, and at the bottom from 20 percent to 14 percent, and, across the board, a 30 percent tax cut comes in 1964.

Do you know what else happens in 1964? The term "venture capital" is essentially coined. 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. The term hadn't existed before then, but explodes in usage beginning in 1964.

The term "venture capital" was invented the same year major tax cuts were instituted.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. 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 with the amount of money the 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. These two guys, with a few others, go on to found Intel in 1968, which then enables the personal computer revolution.

They said, "We're going to kind of move away from making guidance systems for the Polaris missile. What we're going to do is embed computer chips into personal devices that can put computers on the 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, the tax rate cuts of 1964, which enabled the venture capital industry. And that's when Silicon Valley came into its own.

Reprinted from Learn Liberty.

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