Public Policy, Economics and Entrepreneurship: April 2010 Archives

My friend Rhonda Abrams has a message for Washington in her latest column at USA Today:  "Listen up, government: Small business is most trusted group."

From her column:

"Be proud, small-business owners! You're now the most trusted group in America. Listen up, federal government! You're neglecting small business -- and most people think so.

"According to the just-released study by the highly respected Pew Research Center, small business is the most trusted institution in America. More than churches. More than colleges. More than technology companies. And certainly more than labor unions or large corporations."

I was sent an e-mail this week that for some reason caught my attention.

It read as follows:

Hello,

I thought you might like to know that America.gov has published a feature on public efforts to promote high-tech entrepreneurship. The feature includes a blog discussion of relevant issues.

Regards,

Andrzej S Zwaniecki
Editor, International Information Programs
U.S. Department of State

How interesting.  The U.S. Department of State has its tentacles in entrepreneurship.

So I went to the link at America.gov.  I must admit, it was my first time at this site. 

The page linked to at America.gov had a quiz.

"Can Your Government Promote Entrepreneurship?" was the headline in bright red at the top of the page. 

Of course, I immediately looked for the "NO" button to click.  After all, if venture capitalists who study high growth ventures for a living have such a lousy record of picking winners -- the good ones get about one out of ten right -- how in the world can government officials expect to be able know where the market will lead us next?

But there was no button that would let me answer "NO".  The site just wouldn't let me answer that first question.  Instead had a second question that I could answer that was part of a quiz:  "You can invest $1 million of public funds to spur high-tech business. What steps will you take? (Click START.)"

So I went ahead and threw caution to the wind and clicked "START".

Up popped the following:

Imagine you are a provincial government official ready to invest $1 million of public funds to kick-start high-tech business. After considering the following hypothetical scenario, test your decisions.

BACKGROUND:
Your province was strong in traditional manufacturing, but recently lost ground to cheap overseas competition, and your government is promising an economic recovery.

Three local universities are doing fruitful research on clean-energy technologies.

As often happens, you hire a consulting firm. Assume that the firm studies the business climate in your province and reports that the $1 million you have to invest to kick-start entrepreneurship should be split among efforts to encourage three types of ventures: 1) clean-energy technology, 2) biotechnology and 3) high technology.

You must encourage local economic growth. You could place strings on the money, matching it only to loans by local investors supporting companies that hire locally, or you could work with more-experienced firms based overseas that want to operate in your province.

The consulting firm recommends converting a former manufacturing facility into a research park/business incubator. Some of the potential tenants, however, prefer to maintain headquarters in their own garages or basements. They want networking opportunities but can't afford office space, even if rent is subsidized.

The consultancy would be happy to manage the entire program, as it provides business-development services. But you can also rely on the local research universities and venture capital firms for advice, and they have a strong interest in the success of local businesses.

As you go on to set up an appropriate entrepreneurship program, you need to answer four questions:

1. Do you split the money into three funds?
2. Do you aim at the developing local businesses or global players?
3. Do you establish a physical or virtual research park?
4. Do you hire the consulting firm to manage the program?

(Click on Questions 1, 2, 3 and 4 and on the options to answer them.)

Source: This scenario is based on opinions of experts who have tackled the topic of what government efforts are likely to succeed in spurring high-tech entrepreneurship. They are authors Josh Lerner (Boulevard of Broken Dreams) and Anthony Townsend (Future Knowledge Ecosystems).

"Wait just a minute," I exclaimed out loud while sitting on my back porch.  "Who the heck are these experts and what do they know about entrepreneurship." 

It seems that Josh Lerner is a Harvard professor of Investment Banking.  Wait just a minute!  Investment banking?  Aren't those the guys who helped get us into the current mess with all of their knowledge of managing markets?

Anthony Townsend is Director of Technology Development at the Institute for the Future out in Palo Alto, California.  His blog is full of ideas on how government can reinvent cities, shape markets, and the like.

Hmm... Sure wish the quiz had given me more options, like maybe "None of the Above."

All of this reminded me of the following quote from Friedrich August von Hayek about the proper role of government in the economy:

"He will therefore have to use what knowledge he can achieve, not to shape the results as the craftsman shapes his handiwork, but rather to cultivate a growth by providing the appropriate environment, in the manner in which the gardener does this for his plants." 

I have to agree with Hayek on this one.  The last thing we need right now is the State Department, an investment banking professor and a futurist trying to craft our economy.

Let's cultivate the economic soil and see what the market spouts!

We need to rethink immigration policy.  As I have written in the past, we need to find creative new ways to open our doors to immigrant entrepreneurs.

A new bill introduced by Congressman Jared Polis (D-CO), would create a Start-Up Visa for entrepreneurs with financial backing from angel investors.  It is H.R. 4259 - The Employment Benefit Act (you can see a summary of the bill here).

Here is how the bill is described in the press release:

Every day the American economy is losing ground--not to mention high-tech jobs and technologies--to India and China because foreign-born entrepreneurs cannot secure a visa to stay in the U.S. That's why I've introduced H.R. 4259, the Employment Benefit Act, to create AMERICAN jobs by bringing our immigration system into the 21st century and encouraging foreigners with good ideas and much-needed capital to invest in our economy, rather than in our competitors. By streamlining and expanding our nation's EB-5 visa program, this much-needed change would unleash innovation into our economy, create thousands of quality jobs right here in America, and bring capital to America to grow American businesses.

But, when looking at the details of this bill it becomes clear that this is another example of Washington policy makers thinking they can predict and control the market.

Rather than open the doors and let the market pick winners, the act targets what markets are eligible and constrains its benefits to specific levels of investment.

What about those immigrant entrepreneurs who do not want or need venture capital or angel backing?  Out of luck with this bill.  While venture capital backed deals are important, they create only a small percentage of new jobs in our entrepreneurial economy.

What about entrepreneurs who want to start a business in a particular market where they see an opportunity?  Only if it is in a targeted geographic area.  Entrepreneurship is a powerful economic tool -- we need to stop trying to hamper this by making it a social policy tool.

We desperately need immigrant entrepreneurs to join in the rebuilding of our economy.  But we don't need bureaucrats serving as the bouncer at the door deciding who can come in.   

A growing number of economists are pulling back from their earlier statements that the economy has bottomed out and is poised to begin its upturn.  It seems that small business owners concur.

The National Federation of Independent Business Index of Small Business Optimism lost 1.2 points in March, falling to 86.8.  The persistence of index readings below 90 is unprecedented in survey history.

"The March reading is very low and headed in the wrong direction," said Bill Dunkelberg, NFIB chief economist. "Something isn't sitting well with small business owners. Poor sales and uncertainty continue to overwhelm any other good news about the economy."

The index has posted 18 consecutive monthly readings below 90.  In March, nine of the 10 Index components fell or were unchanged from February's not-so-great readings.

Some highlights from the March NFIB survey:

• While actual job reductions may have halted, plans to create new jobs remain weak.
  
• The frequency of reported capital outlays over the past six months fell to near record low levels.  A paltry two percent characterized the current period as a good time to expand facilities.
• Widespread price cutting continued to contribute to reports of lower nominal sales.
• Small business owners continued to liquidate inventories and weak sales trends gave little reason to order new stock.
• Earnings trends declined again in March, with 58 percent reporting that profits are falling. 
• Regular borrowers continued to report difficulties in arranging credit. 

"What small businesses need most are increased sales, giving them a reason to hire and make capital expenditures and borrow to support those activities," said Dunkelberg in summarizing this month's survey results.

Economic recovery on Main Street is looking to be a long, long way off.

It is not easy being an entrepreneur in America these days.

The push for higher marginal tax rates, whole new tax programs like the possible VAT tax, and expanding regulation are all making the entrepreneur's already challenging job even more difficult.

And on top of all of that, let's not forget about the zeal with which the IRS is focusing on entrepreneurs.

A new study by the Transactional Records Access Clearinghouse (TRAC) shows that despite a growing federal deficit, IRS audit efforts aimed at the nation's largest corporations have precipitously declined in the last few years and now are at an all time low.

According to Dean Zerbe, alliantgroup National Managing Director and former Tax Counsel on the Senate Finance Committee, "As if April 15th isn't frightening enough for small business owners, now comes news that the IRS has increased audit hours for small and medium businesses by 30% over the last five years, while at the same time decreasing the number of hours spent auditing large corporations by 33%."

TRAC reports that the average claimed tax underreporting per hour for small and medium businesses is $1,025, and for large corporations it's $9,354.  The TRAC study shows that over the past few years, despite a big upswing in the number of hours auditing small and medium businesses, the number of no-change audits (audits that resulted in no change to the tax owed) has stayed approximately the same, and the number of dollars collected per hour has also stayed roughly the same. At the same time, the dollars collected per audit-hour of large corporations has gone from $6,594 in 2005 to $9,354 in 2009.

Unlike a large corporation that may have on staff a dozen tax attorneys who would have little to do if the IRS didn't call, an audit for a small or medium business is costly and may cause economic harm to the company - even if the IRS doesn't find anything wrong.

"Often the audit of a small or medium business will require the time and attention of the business owners themselves - time that could be spent improving and expanding their business and hiring new employees," says Zerbe.  "While politicians in Washington love to give speeches touting how small businesses are the engines for job growth, revving up IRS audits of small business is like putting sugar in the gas tank. The administration needs to rethink a strategy that we can audit our way to creating new jobs."

Just when we need them most to lead us out of the economic doldrums, entrepreneurs are under attack.

Jeff Hartline, a candidate for the 5th Congressional District in Tennessee, puts it this way at his blog Signers and Framers:

"There has been a serious effort over the past 40 years to preserve endangered animal and plant species. The Bald Eagle, American Alligator and many others have been returned to proper numbers in their respective habitats. With only a few exceptions, this has been a worthwhile venture.

"However, we are now faced with the prospect of an endangered species that could spell the end of American liberty as we know it. That endangered species is the entrepreneur. For centuries, this species has been responsible for generating employment, providing goods and services, supporting the tax base, and moving the creative spirit forward.

"However, the Progressives have mounted a relentless campaign through the media, churches, and government to vilify these small engines of prosperity."

Today is Tax Freedom Day.  That mythical day when we are done working to pay for our taxes for the year.  Except now that we are running up a huge federal IOU each year in our exploding deficits, a bill we will all have to pay in more ways that one, the Tax Foundation estimates that if we were actually paying now for all of our government spending, Tax Freedom day would occur until May 17th.  Of course that is only for the 53% of Americans who actually pay federal income tax.

A debate going on about Tax Freedom Day between Joseph Henchman at Tax Policy Blog and Chris Bergin at tax.com puts clarity to the basic issues of spending and taxation in America today.

Says Bergin:

"The truth of the matter is that, other than the chuckle I get from the whole thing, Tax Freedom Day doesn't mean a thing. As a society, we will never be free of taxes - that is unless we all want to be bathing down by the river, catching our own dinner, and freezing to death in the dark.

"And currently as a society we don't pay enough taxes, not enough to pay for the government services we demand. A lot of Americans don't want their Medicare, Social Security or new Healthcare touched. They also don't want to pay more taxes.

"Now, how, precisely, does that work? It doesn't. Maybe I can come up with a Tax Stupid Day."

Henchman's reply:

"I'm no anarchist but it sounds like Bergin is alluding to the opposite extreme: that every tax dollar is vital to the functioning of society. This isn't the case: the value from a well-functioning and impartial court system is different from the value from ethanol subsidies, the U.S. Institute of Peace, and the National Watermelon Promotion Board. Those may be nice programs for some people but they aren't exactly vital to keeping the lights on. We could have a smaller tax burden and not be foraging for berries and boar meat....

"The solution to badly-designed social welfare programs should not be knee-jerk higher taxes, but reforms and a sustainable, broad-base/low-rate tax system that encourages economic growth and minimizes interference with individual freedom. And all this means that Bergin, us, readers, and everyone should be working to learn more about tax burdens, who pays and who benefits, and how the trends are going. Tax Freedom Day is one of those tools, and I'm pleased to be a part of the debate."

Since tax rates are one of the most important predictors of entrepreneurial start-up rates and of the longevity of small businesses, I am pleased to continue to be part of the debate, as well.

It seems that Washington has a plan to pay for all of this new spending.  It is another large and complex tax system that seems to be steamrolling its way toward Main Street.  Get ready for our own version of a VAT tax.

A VAT tax is one that is added at each step of the production and distribution of a product.  It is calculated by estimating the market value added at each stage of its manufacture or distribution.  Although much of this tax is hidden from the consumer's view (there goes transparency once again....), it is of course ultimately passed on to the consumer in higher prices.

This is not the same as a simple and very transparent sales tax, which is my tax of choice.  VAT is not just added at final point of sale, it accumulates along the way.

What does this mean for small business?  Much more complicated tax compliance.  If you want to see how complicated it can get, look here at how the VAT works in the UK.

James Pethokoukis has been keeping us posted as to the progress of this new tax at his blog.  In his latest post on VAT, he describes a scenario (not the one being talked about currently in Washington that places this on top of the current income tax system) in which a VAT might make sense and be supported by the public:

"First, Washington would have to demonstrate it could manage the public purse by reforming entitlements in a Ryan-esque manner. A tall order, but a necessary prerequisite or else voters would fear that entire six-point budget gap would be closed by tax hikes via a VAT. So, in the end, government spending needs to be dramatically cut. (Preferably, we would never need to get past this step.;)

"Second, a VAT would have to completely overwrite the current complex and inefficient tax code. If not, voters would fear getting hit by both VAT and income tax hikes. A VAT can't be an add on.

"Third, every sales receipt in America would have to indicate the VAT penalty. But politicians love the hidden aspect of a VAT as way of duping voters. To them opaqueness is a feature, not a bug.

"Fourth, the intended tax burden should be kept level at first. A pro-growth VAT -- one that does away with corporate and investment taxes -- might produce more revenue merely by expanding the economic pie."

Although I might buy into this scenario, I doubt the government-happy politicians in Washington would support his plan.

Tom Friedman offered his thoughts on what we need to do to get the economy going in an op-ed piece at the New York Times.  His take on how to revive the economy:

"Good-paying jobs don't come from bailouts. They come from start-ups. And where do start-ups come from? They come from smart, creative, inspired risk-takers. How do we get more of those? There are only two ways: grow more by improving our schools or import more by recruiting talented immigrants. Surely, we need to do both, and we need to start by breaking the deadlock in Congress over immigration, so we can develop a much more strategic approach to attracting more of the world's creative risk-takers."

Immigrants have always played a vital role in fueling our entrepreneurial economic engine.  Given our need for help in revving up that engine right now, I wish we would take another look at our immigration policy.

The primary reason that we see so many immigrants pursue entrepreneurship is that they are opportunity focused - surveys reveal that this is what drives many of them to leave for a new country.  I have to wonder how attractive the US will look in a few years after our mad dash to socialism is fully in force. 

When we look within specific ethnic communities in the US, recent immigrants out perform non-immigrants in economic achievements and have higher rates of self-employment than native-born in these ethnic communities.

In Internet-based ventures, immigrant entrepreneurs pursue more aggressive strategy.  One study found that 25.4% of engineering and technology companies include at least one founder who was born outside of the US.

Here are a few more quick facts:

• Immigrants represent 12.5 of all business owners.
• Immigrants are 30 percent more likely to start a business than non-immigrants are.
• Immigrant business owners are concentrated in certain states, including California, New York, New Jersey, Florida, and Hawaii.
• Mexicans represent the largest number of immigrant business owners, while Greeks, Koreans, and Iranians have the highest ownership rates

In the 1900s we viewed immigrants as a source of cheap labor.  Our immigration policy -- or lack thereof -- has reflected this. 

To help create jobs and growth we should open our doors to entrepreneurs from around the globe.  Current policy makes it difficult for entrepreneurs to enter the US legally.  We should be actively recruiting immigrants who want to come to our system of free enterprise to start their businesses, just as we did to bring in the scientists we needed in the 1950s and 1960s to help fight the cold war. 

The last great entrepreneurial economic boom was created in large part by first generation Americans and sustained by a large, but controlled, wave of immigration that helped to build an economy that last through most of the 1900s.

 

In addition to a "green card" for immigrants coming here to work, the US also needs another card (let's color it a "red card" for urgent) to support the flow of legitimate entrepreneurs looking for the freedom this country offers to business owners.