Public Policy, Economics and Entrepreneurship: April 2008 Archives

The Brookings Institution has been busy pushing forward on an agenda for socialized entrepreneurship. Two items from the National Dialogue on Entrepreneurship this week caught my eye (and raised the hair on the back of my neck). First:

A new report from the Information Technology and Innovation Foundation and the Brookings Institution suggests that a new National Innovation Foundation could do a better job of structuring key Federal agencies to support innovation. The study recommends that a newly created National Innovation Foundation serve as the Federal government's primary support mechanism and point of contact for issues related to innovation. The report proposes three possible structures for a new NIF: housed within the Commerce Department; a publicly-sponsored corporation similar to the Corporation for Public Broadcasting; and, as an independent federal agency like the National Science Foundation.

I must admit I would never have dreamed of modeling anything after the Corporation for Public Broadcasting. Next. another report. I should note that both of these are from the same series, which they call Blueprint for American Prosperity: Unleashing the Potential of a Metropolitan Nation:

A new Brookings Institution study contends that current Federal policies do too little to promote cluster creation, i.e. agglomerations of businesses, service providers, and other partners who operate in a particular field or sector. As part of a wider set of programs to spur innovation, the report recommends that policymakers initiate a new set of programs to catalyze cluster activity across the US. This effort would contain two components. First, a Cluster Information Center would help map cluster initiatives across the US and provide research and evaluation about these programs. This effort is modeled on a successful European effort, the European Cluster Observatory. Second, a new Federal grant program (of about $360 million) to help fund state and regional cluster initiatives. This effort would help seed state and local innovations and also build closer connections between Federal, state and local partners.

And while we're at it, let's create another federal agency promoting rent seeking and model it after a European agency that tries to steer business activity to advance social agendas. No thanks, Brookings! Keep your hands off American free enterprise! Markets work. Federal bureaucracies do not.

I was at a meeting attended by several local entrepreneurs the other morning. They all agreed that everyone is worried that the economy is in bad shape, but none of them were really feeling recessionary pressures in their businesses. The only thing that worried them directly was inflation. In economics, perception can very quickly become reality. With enough talk about a bad economy we can all start behaving like there is poor economic conditions. Take the latest results from the OPEN survey from American Express Small Business Monitor as a case in point. Optimism among small business owners is at the lowest point in the six-year history of the OPEN survey. The economy is cited by four in ten small business owners (44%) as the issue that will most sway their decision on the next president of the United States, followed at a distance by homeland security (cited by 16%). HOWEVER, despite concerns over the economy, growth is still a priority for entrepreneurs as seven in ten business owners plan to grow their business over the next six months and 31% of entrepreneurs report plans to hire, up 7% from the fall. That is the psychology of mass panic that can make a weak economy seem worse than it really is. The media loves bad news (as they used to say -- "It sells newspapers"), so they have an incentive to make even worrisome news about the economy sound much more dire than it actually is at the present time. It can also lead to behaviors that make the economy become worse than it otherwise might have. Are we in a slow down? Yes. Is it across all sectors? No. Is it across all geographic regions? Definitely not. Are we in a recession? Not yet, and if small business has its way and pursues the growth plans they are talking about, I doubt we will actually experience a true recession. However, I still remain very concerned about inflation. Very, very concerned.

Today is the mythical day known as Tax Freedom Day. For some this day actually occurs around Valentine's Day, while for others it is actually in the dog days of summer. Here is a summary explanation from the Tax Foundation:

Tax Freedom Day will arrive on April 23 this year, the 113th day of 2008 (ignoring Leap Day). That means Americans will work nearly four months of the year, from January 1 to April 23, before they have earned enough money to pay this year's tax obligations at the federal, state and local levels. Americans, as a whole, work a significant number of days each year to pay for things other than government, but nothing else is so expensive. Americans will work longer to pay for government (113 days) than they will for food, clothing and housing combined (108 days). In fact, Americans will work longer to afford federal taxes alone (74 days) than they will to afford housing (60 days). As a group, Americans will also work longer to pay state and local taxes than they will to pay for food. Tax Freedom Day had arrived later for the four previous years, but due to an expected slowdown in the nation's economy and a massive one-time fiscal stimulus tax cut passed earlier this year, Tax Freedom Day is projected to arrive three days earlier this year compared to last year.

Here is a graphic of what we spend our income on in the US: Or for a lighter version of the same story check out this YouTube music video of Tax Freedom Day. If the three presidential candidates have their way, it could be much later in the year for all of us within a few years. In fact, it might even make the late 1990s (during the last Clinton administration) look good. Here is tax freedom day graphed over time:

From the testimony of the Tax Foundation's Vice President for Economic Policy Robert J. Carroll before the Senate Finance Committee this week:

...[F]undamental tax reform has the potential to reduce the compliance burdens imposed on both households and businesses, and at the same time create an environment for greater economic growth in the long-term in a manner that is appropriately fair. A fundamental issue...[is] the choice between income-based and consumption-based taxes. Consumption taxes generally reduce the tax on saving and investment, and... [will] boost economic performance and living standards in the longer term, in a way that retained the current progressivity of the tax system. ...[R]eforming the corporate income tax is becoming more urgent as our major trading partners around the world take the initiative.

Tax compliance (not taxes, just the paper work they create) costs small businesses more than $1,300 per employee per year. That is $26,000 for a small business with twenty employees that could have gone to adding another employee or expansion. The corporate tax levied by most states in the US is higher than the corporate tax rate of country of France. Even socialist nations are finding the benefits of lower tax rates for their economies. But, there is no relief in sight for those of us in the US. None of the three remaining Presidential candidates have real tax reform or tax cuts in their platforms. All three include policies that will significantly expand government, and in turn, will create the need for higher taxes to support their new initiatives. Not only are jobs going overseas, but so are the entrepreneurs we need to help transform our economy. We have always benefited from the entrepreneurial spirit of our immigrants. More and more immigrant entrepreneurs are finding that they can find more opportunity in their home countries. Bad news all around for the long-term outlook for this entrepreneurial economy.

The House Committee on Small Business is talking about using the tax code to stimulate small businesses the economy. From their news release (via beSpacific and Ben Cunningham):

Times change and so should the tax code, but with tax day less than a week away millions of entrepreneurs are facing outdated IRS provisions that stifle their ability to boost the economy. Today, the House Committee on Small Business heard from a panel of business owners and tax experts at a hearing focused on modernizing sections of the code while making it more small business friendly. As part of the forum, the Committee also issued a report titled "Seven Ways to Stimulate the Economy by Updating the Internal Revenue Code," which provides specific recommendations on fixing provisions that impact small firms.

What they are proposing is what is euphemistically known as tax reform.  However, note the following graph:
See the spike in the number of pages in the tax code after the early 1980s? That's what happened after the Reagan "tax reform". The tax code actually got much more complicated when they sold it as a "tax simplification." Finding seven ways to tweak the current code will do nothing to help small businesses in the economy. Pulling the current tax code out by the roots and starting fresh with a sales-based federal tax that is protected from special interest meddling will. Small businesses spends over $1,300 per employee just on tax compliance under the current system. Beware of the Trojan horse called "tax reform." It will only make things worse.

There is more talk these days from Washington and from those on the campaign trail that government needs to take an active role guiding the economy.  With entrepreneurship the driving force in our economy, and for that matter in most economies around the globe, this is an alarming trend.  Sen. Clinton is talking about the need for the federal government to set our economic priorities and strategies.  

This is absolutely counter to all that we know about the appropriate role for government in entrepreneurially-based economies.  The more government gets involved in managing economies, the more complex the tax code gets (they use this to shape our behaviors) and the more regulation inevitably follows.  These are two of the major factors that stifle entrepreneurial activity.

But, the activist approach to economic policy (what I like to call socialized entrepreneurship) also creates lots of mischief that leads to even more regulation and government intervention at the micro level.

Case in point from governmentexecutive.com:

The chairman of the Senate Small Business and Entrepreneurship Committee is demanding an explanation from the State and Defense departments for how a wealthy 22-year-old arms dealer, under investigation for providing decades-old ammunition to Afghan security forces, was inappropriately classified as a small disadvantaged business on dozens of federal contracts. Responding to an April 3 report from Government Executive, Sen. John Kerry, D-Mass., sent letters to Defense Secretary Robert Gates and Secretary of State Condoleezza Rice on Thursday requesting responses about AEY Inc. of Miami, and its owner, Efraim Diveroli. Kerry is interested in how AEY obtained its SDB designation -- despite never requesting or garnering such a classification from the Small Business Administration -- and if the company received any preferential treatment as a result of the mistake.

Just as people seek to exploit opportunities in the market, they will seek to exploit artificial market opportunities created by government policies.  That is why big government Republicans are quite happy with the status quo of the current 65,000 page tax code.  Those who help shape the code through lobbying also get to exploit it economically.  

But, not to worry.  Sen. Kerry has it all under control.  He has called for hearings, which will surely solve all of the problems created by the regulatory mess he and others in Washington helped to create in the first place.  More rules, more regulation, more hearings.....  it never ends.

(Thanks to Ben Cunningham for passing this along).

Recession clouds appeared in the skies over Main Street, according to the most recent National Federation of Independent Business Small Business Economic Trends member survey. The NFIB Index of Small Business Optimism fell 3.3 points in March to 89.6 -- its lowest reading since the monthly surveys were started in 1986, and the lowest quarterly reading since the second quarter of 1980. The decline was driven by a sour outlook for business conditions and real sales growth, accounting for half the decline in the Index. Weaker plans to create new jobs accounted for 21 percent of the decline.

"We are seeing recession readings," said NFIB Chief Economist William Dunkelberg.

What is worse is that the labor market is still somewhat tight and price pressures continue to push costs up.

More signs that stagflation might be on the horizon.

One of the myths about entrepreneurship is that high growth, high potential ventures (some call them gazelles) are the main driver of economic growth. For example, consider this quote from National Dialogue on Entrepreneurship: "High-growth businesses -- sometimes known as gazelles -- -are the real drivers of innovation and economic growth in our economy."

High potential businesses are those that tend to attract venture capital. VCs need businesses that yield very high returns in a very short time -- some will tell you that they seek 100% annual returns with an exit within 3-5 years and others simply say they seek 5 times their initial investment within about the same time period. However, gazelle companies represent a tiny fraction of 1% of entrepreneurial ventures.

Do they have an impact? Of course. Are they the "main driver of our economy"? No.

Those boring little entrepreneurs who toil away with only their own investment -- maybe with a little help from their family and friends -- is what really drives today's entrepreneurial economy. It is these small businesses that now generate about 50% of the US economy and have created 77% of new jobs for the past twenty years. They do so with ingenuity, bootstrapping, passion, persistence, and as Monroe Carell told our students yesterday, patience.

Gazelles quickly get absorbed into corporate America within 3-5 years if they have any success. The average entrepreneur is not even considered successful unless the business lasts at least five years. They are in it for the long run.

Rather than measuring success in terms of mind-boggling returns to investors, the average entrepreneur measures success in terms of making a living for his/her family, by creating good jobs, by becoming able to contribute to building a better community.

Don't misunderstand my point. I like high growth. high potential businesses. We get a few coming through our program and they are challenging, interesting, and fun to watch. I hope we get more.

But, they are not the heroes of our entrepreneurial economy. That title belongs to the average entrepreneur who will never get a dollar from a venture capitalist -- who builds a successful business seemingly out of almost nothing.

Average entrepreneurs may not be "gazelles", but they are the work horses we need to move this economy steadily into future.