There is something just a bit odd about Senator Carl Levin’s recent attacks on Facebook. The Michigan Democrat says that the social networking company is exploiting a tax loophole in order to avoid paying taxes to the government.

“When it comes time to pay taxes, to pay Uncle Sam,” Levin says, “the loophole in the tax code allows the company to take a tax deduction for a far larger expense than they show on their books.” “American taxpayers will have to make up,” Levin says. “for what Facebook’s tax deduction costs the Treasury.”

Here’s what’s happening. Mark Zuckerberg’s compensation from Facebook comes largely in the form of stock options. When he realizes those options he will in effect be paid for his work building Facebook. That compensation will be billions of dollars. And he will pay taxes on those billions at the highest federal rate.

Facebook, the corporate entity, meanwhile, will not have to pay taxes on the amount of compensation Zuckerberg makes in the form of his options. This is the supposed “loophole” that bothers Senator Levin. Contrary to Senator Levin’s insinuation, American taxpayers aren’t going to have to make up a thing; Uncle Sam is going to be paid plenty. He’ll be paid astronomical sums of money in taxes by Mark Zuckerberg.
"Contrary to Senator Levin’s insinuation, American taxpayers aren’t going to have to make up a thing; Uncle Sam is going to be paid plenty." -Nick Schulz

Where’s the harm here? From the U.S. Treasury’s standpoint, it’s mostly a wash, since the Treasury will be paid handsomely regardless of whether it’s the company or its founder paying the tax.

Levin is not claiming Facebook and Zuckerberg are doing anything illegal. “I emphasize that Facebook’s actions are within the law,” Levin said. “As with so much of our tax code, it’s not the law-breaking that shocks the conscience, it’s the stuff that’s perfectly legal.”

But there’s nothing shocking about any of this. The tax code is structured this way in part to encourage the creation of start-up companies – companies like Facebook.

One thing start-ups often lack is ample cash to pay employees, especially during the early years before they generate much revenue. Cash-strapped companies can find it difficult to find talented people to work when they can’t pay them competitive salaries.

But start-up companies can attract needed talent by offering options as a form of delayed compensation. If the company does well, and the options become valuable, the employees will ultimately get paid for the work they’ve done. And they will pay taxes on that compensation, just as Zuckerberg will do. If the start-up fails, and the options expire worthless, the employees granted those options receive nothing.

Indeed, it’s a good thing this system is in place to help encourage risk-taking and entrepreneurship. It’s good for the economy as it encourages the creation of new high-growth companies. It’s also good for the government. As TechNet’s Rey Ramesey recently noted, “Eight years ago Facebook did not exist, but today its employees and the entire ecosystem it generated will deliver billions in state and federal tax revenues."

Even more important is to understand that a relatively small fraction of the wealth created by entrepreneurial activity is actually captured by the entrepreneurs themselves.

Yes, Zuckerberg is going to become phenomenally rich, as will other Facebook executives. But entrepreneurs typically capture but a slice of the total wealth they actually help bring about. The rest of that wealth spills over to society at large as it becomes more productive and wealthier over time.

All of which makes Levin’s assault with this tax “loophole” so puzzling. Facebook is a textbook case of win-win-win. Facebook’s creators get rich thanks to their vision, hard work, and risk-taking. Society gets the benefit of an innovative communications platform that enriches people’s lives. And the U.S. Treasury gets billions in new revenues from Facebook’s employees and investors as well as from the broader economic boost kickstarted by the social network.

What’s not to like?

Nick Schulz is the DeWitt-Wallace Fellow at AEI.