Public Policy, Economics and Entrepreneurship: May 2007 Archives

It now looks like the SEC is willing to reconsider their decision not to extend the deadline for small public firm compliance with section 404 of the Sarbanes-Oxley Act. The Office of Advocacy of the SBA wrote to the commissioners in the wake of the SEC's decision not to grant postponement of deadlines for public firms with less than $75 million in market value. You can read the contents of the Office of Advocacy's letter here.

Keep in mind that this is merely an attempt to postpone the deadline. At some point compliance will probably be required of all public companies -- even the small ones. The estimated $500,000 in compliance costs per year is unfathomable for many of these smaller firms. And even worse is the fact that these rules will creep into the accounting standards for non-public firms, as well.

From the National Dialogue on Entrepreneurship:

The latest assessment of entrepreneurial activity by the Ewing Marion Kauffman Foundation provides startling numbers for yet another year. The new report shows that an average of 465,000 people creating new businesses each month in 2006. Besides year-to-year changes in entrepreneurship activity, the Kauffman Index -- defined as the percent of the adult U.S. population of non-business owners who start a business as their main job each month -- captures long-term trends. The 2006 figure is up slightly from the previous year, it is equal to the average rate for the past ten years. Other highlights from the past year include: Asians, Latinos and immigrants far outpaced native-born Americans in entrepreneurial activity; African Americans experienced a decline; entrepreneurial activity for men did not change between 2005-2006, ending a downward trend that began in 2003; and, the rate of entrepreneurial activity for women declined slightly. The report also contains data on activity at the state level. The five states with the highest rates of entrepreneurial activity were Montana, Mississippi, Georgia, Oklahoma and Maine. The five states with the lowest rates of entrepreneurial activity were Michigan, Pennsylvania, South Carolina, Illinois and Delaware.

After my post last week on small businesses and lawsuits, Ryan Zempel, Managing Editor of InstituteforLegalReform.com sent along a couple of interesting links.

The first is to a study called Tort Liability Costs for Small Business. This study shows that small businesses (those with $10 million or less in annual revenue) bear 69 percent of the total cost of the tort system to all U.S. businesses. That's $98 billion a year, or $200,000 per year for a business with $10 million in revenue, on average.

The second link is to a survey titled Small Businesses: How the Threat of Lawsuits Impacts Their Operations. This survey shows that, of those who expressed some concern about frivolous lawsuits, six in ten say the fear of lawsuits makes them feel more constrained in making business decision.

This afternoon the NFIB released a major new study on small business and health care. Here are the key findings from this survey of small business owners:

- Cost is Most Important to Business Owners. When asked the single most important problem facing the health care system today, 74 percent of NFIB members identify cost. Expanding coverage ranks third at 9 percent. Given a second choice, an additional 20 percent identify cost (94 percent a first OR second choice); 28 percent note expanding coverage (37 percent a first or second choice).

- Information on Costs Helps. Seventy (70) percent of NFIB members think that making consumers more sensitive to health care and health insurance costs will encourage consumers to use less health care; 28 percent do not think it will. Increasing consumer price sensitivity can reduce health care prices. Steps to increase consumer sensitivity to and awareness of health-care (insurance) prices are a good thing.

- Premiums Should be Individualized. Seventy-six (76) percent think individual behavior that influences health outcomes should be included in the calculation of health-insurance premiums. Two obvious examples are smoking (89 percent in favor) and body mass/weight (72 percent in favor). They are less certain about other specific behaviors such as driving record (44 percent) and frequency/intensity of medical use in the last five years (51 percent). They also hold mixed views on factors such age (51 percent -- fair), location (39 percent -- fair), family medical history (35 percent -- fair), and credit score (16 percent -- fair). However, small-business owners do NOT think any of these factors should be grounds for insurance denial by a 69 percent – 30 percent margin.

- Healthcare Coverage Should be Voluntary. Fifty-eight (58) percent of NFIB members think the employer's role should be confined to voluntary provision of employee health insurance. Another 7 percent think provision of employee health insurance should be mandatory. Still, another 3 percent favor a payroll tax of some type to finance employee health insurance. Thus, 68 percent favor employers continuing to play a role in health-care financing. Thirty (30) percent disagree; they think the employer should have NO role in financing health insurance. The larger portion of this group (23 percent) think individuals should be responsible for themselves (employers excluded), while the smaller portion (7 percent) think government should be responsible for them (employers excluded).

- Keep Government Subsidies Out of the System. Fifty-seven (57) percent think the government, i.e., taxpayers, should NOT financially assist those without private health insurance or Medicaid. 42 percent think it should.

We hear so much about the health insurance crisis faced by small business owners, which is a real problem. However, liability insurance is at least as major an issue for small business owners.

Today in testimony before the U.S. House Committee on Small Business, NFIB Legal Foundation Executive Director Karen Harned laid out a strong case for liability reform. Specifically, she argued for legal reform that makes Rule 11 sanctions (which includes sanctions on lawyers and law firms that are party to frivolous law suites) mandatory for frivolous lawsuit filers.

Harned rightly pointed out that for the small business with five employees or less, the problem is the $5,000 and $10,000 settlements, not the million dollar verdicts. She said that when you consider that many small businesses gross $350,000 or less a year, which does not include the additional expenses of running a business, such as payroll, rent, cost of goods sold, or regulatory costs, $5,000 - $10,000 can significantly impact a small-business owner's bottom line.

Harned provided examples of small-business stories of lawsuit abuse including the now famous Washington, D.C. dry cleaner's pants suit case, where the plaintiff, Administrative Law Judge Roy Pearson, is suing the family-owned dry cleaner shop for $65 million over a lost-and-found pair of pants.

What is most frustrating is that so little attention is given to liability reform in the media, while we hear a constant drum beat for health care reform. The media continues to have a bias that obscures the fact that both issues are serious threats to the future of our entrepreneurial economy. In a recent survey conducted by the NFIB, small business owners ranked the Cost and Availability of Liability Insurance as the second-most important problem facing small business today, just behind health-care costs.

One of my favorite writers and thinkers on the importance of freedom is Fr. Robert Sirico with the Acton Institute. I encourage you to read the text of a recent speech he gave a Hillsdale College, in which he argues that capitalism and its inherent freedom offers the most hope for the common good. Here is an excerpt:

We are all entitled to call ourselves socialist, if by the term we mean that we are devoted to the early socialist goal of the well-being of all members of society. Reason and experience make clear that the means to achieve this is not through central planning by the state, but through political and economic freedom. Thomas Aquinas had an axiom: bonum est diffusivum sui. "The good pours itself out." The good of freedom has indeed poured itself out to the benefit of humanity.

Regulation hurts entrepreneurial economic development. That has been shown in study after study. Still not convinced? Well, take a look at West Virginia. These pictures are from a new study that shows a stark picture of how too many regulations hurts the economy in West Virginia. They show major economic activity right across the border in states with friendlier economic climates.

A video of a local news report of this study can be viewed at Tax Tennessee's website.

Bill Hobbs wrote a great analysis of the impact of the most recent tax cuts on our economy. His essay can be found at the website called Elephant Biz.

The best sources of ideas for businesses comes from your experiences and interests. Many great businesses have been built out of hobbies and other passions. Often these businesses start very small, as what some call "lifestyle" businesses that eventually create a little income. Over time, the entrepreneur is able to transition from a few evenings and weekends to a full-time business.

But now our friends at the IRS are throwing a kink in this cool way to become economically independent. From StartupJournal:

The Internal Revenue Service is stepping up efforts to prevent taxpayers from deducting losses on activities that aren't genuine businesses run to make a profit. The problem: It's not so easy to tell a budding business from a hobby.

Officials say new research shows taxpayer errors in this area are costing the government billions of dollars a year in unpaid taxes. Thus, auditors are "on the lookout" for people trying to deduct losses from hobbies, an IRS spokesman says. To underscore the agency's concern, the IRS recently issued a fact sheet the spokesman says is aimed at "making sure that taxpayers know and abide by the rules."

Sure.... We should all expect some poor person turning their craft or hobby into a business to know the over 60,000 pages of "rules" that are the IRS code.

The story goes on to illustrates this point:

But how are you supposed to figure out whether your activity qualifies as a genuine for-profit business? That can be exceptionally tricky. The IRS says you should consider several factors, such as: Does the time and effort put into the activity indicate you intend to make a profit? Do you and your advisers have the knowledge needed to carry on the activity as a successful business?

Another factor is whether you have made a profit in the past. The IRS says it "presumes" an activity is indeed carried on for profit if you have made a profit during at least three of the past five tax years, including the current year. (The rule is different -- at least two of the past seven years -- for activities that consist primarily of breeding, showing, training or racing horses.)

The IRS has some handy "tips" at their website and there is more information at WorldWideWeb Tax.

Since a part-time business rarely can afford strong outside tax advice, the key is to be cautions and realistic on how you approach your business and make sure to keep very good records. Don't mix expenses and revenues that may create red flags. And keep good records, including a separate checking account for your fledgling business venture.

Once again entrepreneurs seem to be getting a bit grumpy about the economy according to the latest poll just released by the NFIB.

Capital spending activity by small firms remained lethargic. The frequency of reported capital outlays over the past six months was flat at 60 percent of all firms. Forty-three percent reported spending on new equipment, 23 percent acquired vehicles, and 13 percent improved or expanded their facilities. Seven percent acquired new buildings or land for expansion and 13 percent spent money for new fixtures and furniture.

Just 29 percent of owners plan to make capital expenditures over the next few months -- down four points from March, reflecting pessimism among of owners about the prospects for economic growth.

Twelve percent of the owners expressed the view that the current period is a good time to expand facilities, unchanged from March and a rather weak showing. A net-negative 8 percent expect business conditions to improve over the next six months, down a point from March but typical for the later stages of an expansion. A net 14 percent expect higher real sales, unchanged from March and eight points below January.

Other signs of their pessimism can be seen in inventories, which are down in this survey, and a general avoidance of taking on any new debt.

What makes matters worse is that the pesky demon known as inflation just won't go away either. This is what has given me the most heartburn about our economy over the past year.

Also, the SBA Office of Advocacy released the updated Quarterly Indicators: The Economy and Small Business today, which indicated that overall economic growth slowed in the first quarter of 2007.

Forbes has released its latest tax misery index. See the details of their report here. Europe continues to be well represented on the list of heavy tax burdens.

I had the pleasure of hearing a talk by Erik Peterson of the Center for Strategic and International Studies. If you ever have the opportunity to hear him speak, by all means take advantage of it. His talk was on the world as his organization sees it in 2025. It is called Seven Futures (this web link as a great deal of detail on his analysis and presentation). The seven futures refers to the seven parts of the world outside of North America. Even if you are running a small business in the middle of Kansas, the world economy is, and increasingly will be, having an impact on your business.

A quick summary of the world in 2025 and beyond:

- The world is not positioning itself well for the growing entrepreneurial economy. Regulation, property rights and instability are all great concerns.

- Brazil, Russia, Indian, and China are key countries to follow (in addition to the US)

- By 2025 the developing world will account for over 50% of the total economic output

- Latin America does not have a good long-term outlook, due to over-regulation, governance "fatigue", and political alienation. Although becoming a major force, Brazil will most likely fall short of its potential to become a world economic power.

- Europe will never see true integration via the EU (which in my opinion is a good thing). Social welfare systems will be pushed to the brink with falling worker to retiree ratios. Although immigration may be necessary to sustain the workforce, anti-immigration attitudes are growing.

- Middle East and Africa has a rather worrisome mix of rapid population growth, modest economic growth, political instability and conflict, all mixed together with religious extremism.

- Sub-Saharan Africa has a long term AIDS crisis and increasing undernourishment. The glimmer of hope lies in untapped fossil fuels to boost the economy if they can be properly managed and governed.

- Russia and Eurasia has a weak economy with a population that could decline by a third by 2050. Aging population and health crises from environmental disasters put further strain on this region. Governance is key with massive reform, but the outlook of this seems bleak.

- South Asia has the potential to be an economic powerhouse, especially India. India is on track to be the most populous country by 2050. The relationship (or lack there of) between India and Pakistan is the only wild card.

- East Asia is the other potential economic dynamo, but interestingly China has only about a twenty year window to get it right. Their one-child policy is going to lead to a rapidly aging population with a dramatic shortage of females in China. Economic liberalization is unlikely.

My wife and I, two people squarely in the middle of the Baby Boomer Generation, have two great soon-to-be-college-graduate children who are squarely in the middle of the Entrepreneurial Generation (or as it is also called, Generation Y). Several recent studies seem to indicate that these two generations are leading the charge in the entrepreneurial economy today. So I read with great interest a new study released this week by OPEN from American Express about these two entrepreneurial demographic groups.

Here are a few highlights from this latest study:

- 36% of Generation Y small-business owners would jump right back into the entrepreneurial game even if their businesses fail, and surprisingly, 24% of Baby Boomers would do the same.

- Belief by both generations that America is worse off now than when they were kids

- More Baby Boomers say they are naturally energized than their Gen Y counterparts (50% GenY vs. 60% BB) but BB drink, on average, 1 extra caffeinated drink/day (2 GenY vs. 3 BB).

- On average, both groups work 10 hours/day and get 7 hours of sleep at night.

- Both groups agree free trade is a benefit to American entrepreneurs (72% for Gen Y and 69% for Boomers).

- 66% of GenY say they are tech savvy vs. less than half of BB (47%); 88% for both GenY and BB believe experience is more important than tech savvy.

- Both groups agree BB have the edge (59% GenY vs. 66% BB) because of experience.

From the Albany Times Union (via Ben Cunningham):

The former head of a publicly-funded program meant to help jump-start businesses admitted Monday to finagling a fraudulent $95,000 pay raise, using his corporate credit card for a trip to Disney World and insisting his father be included on two business junkets to China.

For months now I have warned that politicians just can't keep their hands off the emerging entrepreneurial economy. They have finally noticed the economic transformation this country is in and are responding by finding ways to gain control and offer favors.

From the National Dialogue on Entrepreneurship:

Congressional Democrats have taken the first step forward in their Innovation Agenda, passing the Small Business Lending Improvements Act of 2007. Aimed at lowering the cost of financing, the legislation would create four new loan programs: a Rural Lending Outreach program; a Community Express program; a Medical Professionals in Designated Shortage Areas program; and, an Increased Veteran Participation program. While passed by the House, the legislation faces opposition from the Administration over the inclusion of subsidies to reduce fees for lenders and borrowers in the 7(a) program.

Rather than empower the free enterprise system that fuels entrepreneurial actions, these policy makers want to take control and pick winners and losers. What we really need is much less intervention, control and regulation if we want to spur entrepreneurship, and not create more bureaucracy as this legislation would do.