Public Policy, Economics and Entrepreneurship: April 2009 Archives

Friedrich Nietzsche said, "That which does not kill us makes us stronger."

So it seems to be for many entrepreneurs during this recession, according to the results of the American Express OPEN Small Business Monitor.

• More than three quarters of entrepreneurs believe managing through the recession has made them better business owners.
• Four in ten business owners have an optimistic outlook on near-term business prospects, on par with one year ago when the macroeconomic climate was significantly different.
• Nearly four in ten entrepreneurs feel the current economic environment creates opportunities for their business.

While optimism has stabilized, business owners are still managing their firms with caution -- bootstrapping more than ever.

Consistent with the NFIB survey I wrote about a couple of days ago, this survey found that capital investment plans remain very low, hiring plans are down significantly, and many entrepreneurs are adjusting their own retirement plans. Forty-two percent of business owners plan to make investments as a way to grow their business over the next six months, down from 53% last spring. Just over one-quarter of entrepreneurs have plans to hire this spring (28%), which is among the lowest Monitor readings in its history.

Small business owners are not taking this recession lying down. Many are finding new resources to tap and new ways to manage costs beyond the traditional steps of laying off staff or cutting back on staff hours. Nearly half of business owners (45%) are open to bartering for new products or services with customers or suppliers and nearly one-quarter (23%) report their barter activities have increased due to the economic environment.

Additional steps include:

• 48% have instituted hiring freezes
• 30% are no longer taking a salary
• 27% have a family member working pro bono
• 25% are renegotiating leases and supply contracts
• 16% have cut benefits
• 18% work a second job

Not all entrepreneurs view the current economic environment as a hardship; a distinct group (37%) says that the current economic environment actually creates opportunities for their business. Among these opportunistic business owners:

• two-thirds have a positive outlook on the economy
• half plan to make capital investments
• just over one-third plan to hire.

Nearly all of these glass-half-full entrepreneurs (92%) say that managing through the recession has made them a better business owner, compared to 77% overall.

From the Tax Foundation:

A new national survey commissioned by the Tax Foundation and conducted by Harris Interactive shows a majority of U.S. adults think that federal income taxes are "too high" (56 percent), while four in every five adults say the federal tax code is complex (85 percent) and say that the tax system needs to be completely overhauled (82 percent).

I wrote recently about the wonderful experience I had this spring teaching a new graduate seminar that explored how entrepreneurship shapes our economy, society and culture. 

What all of the students came away with is an understanding of the true complexity of the issues we face today.  The standard my party is better than your party debate and the bumper sticker solutions that seems to always lead us to just doesn't cut it in times like these.  They discovered how essential it is to dig deeper into the fundamental assumptions, the data we have on what works and what doesn't, and the longer term trends.

The Acton Institute has put together a powerful resource page that provides deep and thoughtful analysis of the current crisis and possible solutions.  It also dives into the moral and cultural issues that are so intertwined with any set of economic policies. 

Brew a fresh pot of coffee and explore some of the writings they are collecting at this site.

Interested in attending a tea party today?  You can find your nearest location here.  There are over 2,000 events planned for today across the country.

The National Federation of Independent Business Index of Small Business Optimism fell 1.6 points in March to 81.0 (1986=100), making March the second-lowest reading in the 35-year history of the NFIB survey.  Two of the index components improved and eight declined, but nothing in the survey indicated a signal that the economy is improving.

Small business owners have yet to be impressed by some recent slightly encouraging economic news.  They remain skeptical, unwilling to commit to more spending or hiring until they see more customers in their stores.
 
The hard components of the index, those measuring owner spending and hiring plans, actually reached a survey record low.

"At this point, it is not clear that we have hit a quarterly bottom in the index, and we can only hope for a reversal and subsequent expansion led by the small business sector," said NFIB Chief Economist William Dunkelberg.  "There are signs that the economy is bottoming in the reports of sales, housing starts and auto purchases, but they were not strong enough in March to lift the spirits of small business owners."

Each year the Small Business and Entrepreneurship Council puts out its index of tax burden for each state in the US.  From their report:

At the state and local levels, taxes have been piling up on small business owners. Many of states and localities continue to increase levies in various ways, including income, property, sales, assorted excise, gross receipts, and death taxes, along with a wide array of fees.

While each and every tax hits business directly or indirectly, different taxes affect economic decision-making in distinct ways. For example, income taxes are the most worrisome, as they impact incentives for working, investing and entrepreneurship. Property taxes affect decisions regarding investments in buildings and housing. And consumption-based taxes can divert and reduce consumer purchases.

You can find an interactive map here.

The top 10 this year includes:

1 South Dakota
2 Nevada
3 Wyoming
4 Washington
5 Texas
6 Florida
7 Alaska
8 Colorado
9 Alabama
10 Ohio

The worst ten states are (OK, DC is not officially a state, but it seems to be headed that way):

42 Massachusetts
43 Vermont
44 Rhode Island
45 Iowa
46 New York
47 California
48 Maine
49 Minnesota
50 New Jersey
51 Dist. of Columbia

Why does this matter?  Taxes, regulatory costs and property rights are the top three predictors of entrepreneurial activity within an economy.  Look for the bottom states to lag when the recovery begins to get in gear.

"Go global!  All businesses are global businesses."

This is what entrepreneurs have been hearing for the past decade.  While this still may be good advice, be prepared to meet additional regulatory challenges due to heightened enforcement of trade laws.

From Entrepreneur.com:

...[D]espite the rhetoric on the campaign trail, the Obama administration and the Democratic majority in Congress have recognized that remaining open to international trade is vital part to the effort to restore the health of the U.S. economy. But another thing that has become evident is that this openness has a price, and that price is enforcement.

The increased cost and inevitably confusion on regulatory compliance will diminish the drive for small business to go global.  This could be a serious damper on small business's ability to lead our recovery.

If you are a small business owner and sell or buy in the global marketplace, you probably need to have access to a lawyer who knows international trade law.  And be ready to add the increased cost of regulatory compliance into your expenses as they could become significant, particularly during the transition to this new policy.

 

Happy Tax Freedom Day! 

The good news -- Tax Freedom Day came a little earlier this year due to the recession and other factors.

The bad news -- When you add on the additional debt that is not paid with current tax revenues, the day you stop pay for government through taxes and your share of the government's IOUs won't come until the end of May!

My friend Bill Evans, President of Evans Glass here in Nashville, has stuck his big toe into the waters of blogging.  His industry group has started a blog at their website.  In his first entry, Bill takes on our current economic troubles:

The great majority of the news is reported negatively. Our economic crisis is reinforced by compounding negativity. The rare positive statements are followed by a grammatical conjunction and subsequent negative statement, i.e., "Durable good orders were up in February as compared to January, but down compared to last year." Forget the comparison to last year. Look at the positive that durable orders increased. Existing home sales are up and new home sales are up. Forget all statements that dilute these positive statements. I tell my sales and office employees to ignore anything that follows a "but" or "nor" conjunction.

He is convinced, and I agree, that our recovery is going to depend on Americans having a major attitude adjustment.  I think that it was President Reagan's positive and hopeful message when he took office that got the economy back on the right track so that his tax cuts could eventually do their job to move us ahead.

President Obama had proposed pumping billions of dollars of debt into small businesses across the US -- what I have predicted will likely create a small business bubble.

There is now some potentially good news out of Washington.  It seems that the banks that would lend these funds, with money coming from the Troubled Assets Relief Program that would be distributed through SBA loan programs, are saying the plan will not work.  From the Washington Post:

The conditions attached to the program, which require these financial firms to surrender ownership stakes to the government and limit executive pay, are so off-putting that these companies say they will not participate.

Industry officials and congressional sources said these issues were raised with the administration before the small-business initiative was unveiled. Nonetheless, administration officials accelerated the announcement, moving quickly to show they were using financial rescue funds to aid not only big Wall Street firms but Main Street businesses as well, sources familiar with the matter said.

What we have here is not just a simple expansion of the traditional SBA loan program, but yet another program that relies on heavy-handed government controls and questionable financial stewardship.

And what did Congress do the last time bankers balked on such a massive infusion of debt into a market?  They strong-armed bankers to join the sub-prime mortgage debacle -- or else.  Let's just hope that history does not repeat itself. 

The NFIB announced their preliminary job creation findings from March, and see a slight glimmer of hope.  From William C. Dunkelberg, chief economist for the National Federation of Independent Business:

 

"March was another bad month for jobs, but maybe not quite as bad as February on Main Street. Seasonally adjusted, there was a decline in average employment per firm of .74 workers reported for the past three months by small business owners in March, large but down substantially from the loss of 1.0 employees per firm reported in February. 

 

"This suggests that the job loss trend is slowing. Six percent (down three points) of the owners increased employment by an average of 3.4 (up 0.8 workers) workers per firm over the past three months, but 28 percent (up four points) reduced employment an average of 4.3 workers (down 0.7 workers) per firm (seasonally adjusted). A mixed picture, but the net was that job loss per firm (including those who did not change employment) declined substantially. The private sector is very weak, with the only job growth likely to come from education, health care and government. 

 

"Ten percent (seasonally adjusted) reported unfilled job openings (down a point), and the percent of owners reporting that finding qualified labor was their top business problem fell to 3 percent - plenty of workers widely available as a result of the sharp contraction of employment that started in fourth quarter of 2008.

 

"Over the next three months, 12 percent plan to reduce employment (up two points), and 12 percent plan workforce increases (down 1 point), both numbers a bit worse than February."

 

However, Dunkelberg sees better times coming toward year end: 

 

"By year end, growth should be positive again, perhaps as strong as 4 percent (annual rate). Large pools of pent up demand are forming and will soon begin to be transformed into actual spending:

 

Here's why real growth will be strong by year end:

 

1. A massive "oil tax cut" of $400 billion if oil prices stay below $50 all year.

 

2. A few million more cars purchased. The current annual rate (9 million) is well below historical scrap rates (about 14 million cars a year).

 

3. A few hundred thousand more new homes started. Housing starts have picked up in 2009 and should continue to grow. The excess supply is in Florida, California, Las Vegas and Phoenix (where prices are 40 percent off of peak). The rest of the country will need to start building.

 

4. Small businesses have postponed capital outlays at 35 year record rates. The longer the recession, the larger the pent up need to make these outlays remains.

 

5. Small businesses have liquidated inventory at a 35 year record pace (and large firms have liquidated as well). This is another pool of pent up demand that will feed orders with a vengeance once owners see the economy bottom.

 

6. Even with 10 percent unemployment, 9 out of 10 people who want a job have a job and will start spending more on deferred but desired activities.

 

7. And finally, some stimulus from Washington."

Let's hope he's correct.

The progressivity of our income tax system not only snares the "rich corporate CEOs", but also many of the entrepreneurs trying to build their businesses.

The effective federal income tax rate faced by small businesses varies by the legal form of organization, according to a report issued yesterday by the Office of Advocacy of the U.S. Small Business Administration.  Average rates range from 13.3 percent for sole proprietorships, which are often the smallest of the small businesses, to 26.9 percent for S corporations.  The effective federal income tax rate is the actual amount of taxes paid by a firm as a percent of its net income.

Overall, small businesses of all types pay an estimated average effective tax rate of 19.8 percent.  Sole proprietorships face a 13.3 percent rate, small partnerships face 23.6 percent, and small S corporations face 26.9 percent. 

The progressivity of the tax code also affects effective rate calculations, as firms with less income face a lower statutory rate.  Nearly 60 percent of small sole proprietorships have a net income of less than $10,000, while only 3.1 percent have a net income of at least $100,000.  On the other hand, more than 18 percent of small S corporations have a net income of at least $100,000.

Most entrepreneurs spend years toiling away trying to get market traction.  Most put their own personal wealth into these ventures.  In fact, recent studies have found that over 85% of funding comes directly from the entrepreneur and his or her family.  At some point, if all goes well, the entrepreneur finally begins to make a profit and earn a living. 

And then just at the time that the entrepreneur begins to gain momentum and build a successful venture, the federal government swoops in and takes away much of the fruits of their success through a highly progressive tax code, that will soon become even more progressive.

I show my students a rather dated video from A&E called "IRS Horror Stories."  It recounts the Senate hearings about a decade ago that looked into IRS abuses of tax payers.  Many of the examples used in the documentary were small business owners.  While the video gets their attention, inevitably a student will say, "But that was ten years ago.  Surely things have gotten fixed by now."

Well, according to a 2008 Syracuse University study, the IRS has significantly increased audits of small businesses.  The study found that the smallest companies were 41% more likely to be audited in 2007 than in 2005, and companies with $10 to $50 million in assets were 29% more likely to be investigated. 

Ranking Member Graves of the House Small Business Committee noted the unfairness of this in his opening statement in a hearing yesterday. "Small firms are less able to hire high priced attorneys and accountants to fight back."

The Committee heard testimony from Douglas Shulman, Commissioner of the Internal Revenue Service (IRS) and Mr. Christopher Smith, owner of S.T.O.P -Northland, a small business near Kansas City, Missouri. 

The purpose of the hearing was to examine the cost of tax compliance for small businesses.  According to the most recent estimate I have seen from the SBA Office of Advocacy, the annual cost of compliance for a typical small business with 20 or fewer employees is $1304 per employee. 

Mr. Smith's story began in 2007 when he learned an employee had embezzled nearly $60,000 from his company.  After contact back and forth with the IRS, and uncovering mistakes by the IRS, an employee of Mr. Smith's was able to negotiate a reduction in his tax payment, although he believes he was then paying the tax for the third time.  "How on earth can an employee negotiate with an IRS agent the amount of a tax due when during an audit they ask specific questions to qualify you as the appropriate person to be liable?" asked Mr. Smith.  Mr. Smith stated that he has spent over 150 hours of his personal time solely to comply with the audit and will never be able to get over the losses.

Rep. Graves concluded by saying, "If small firms didn't have enough stress trying to run a small company in a recession, we burden them with countless laws, regulations, reporting requirements, and continue to do so every year.  We must simplify our tax code and require the IRS to do a better job of helping small businesses to comply.  Small businesses deserve better."

I have a better idea -- scrap the tax code and start over with a simple system that we keep insulated from political meddling.  While I favor a consumption tax like the Fair Tax, I will take any system that eliminates the 67,000 pages of the current tax code.  

The ADP Small Business Report released today shows that 284,000 small business jobs were lost in March. Declines in March and previous months indicate that the resiliency displayed by small businesses earlier in the recession is no longer apparent compared to medium- and large-sized enterprises.

 

The ADP Small Business Report is a subset of the ADP National Employment Report:

 

• Total small business employment: - 284,000
• Goods-producing sector: - 111,000 small business jobs
• Service-providing sector: - 173,000 small business jobs