Small Business

How the Sheer Complexity of Taxes Hurts Main Street: Expert

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Dane Stangler has never owned a small business, and doesn't expect to ever own one. But he's in a position to understand the challenges facing people who own small companies.

Stangler is the director of the Research & Policy department at the Ewing Marion Kaufmann Foundation. His job is to help the foundation determine how it can encourage and mentor entrepreneurs. His department conducts research and surveys and analyzes studies done by researchers at other institutions. So he is familiar with the issues that entrepreneurs and small businesses face.

The Kauffman foundation was started in the mid-1960s by Ewing Marion Kauffman,founder of the pharmaceutical firm Marion Laboratories (now part of the French drug maker Sanofi) and baseball's Kansas City Royals. Part of the foundation's mission is to foster entrepreneurship, something it does through grants and research.

The foundation draws what Stangler calls a blurry distinction between entrepreneurs, the people who start companies or run young enterprises, and small businesses, which Kauffman sees as companies that have made it past their early years. Some small business issues, like income taxes, aren't a problem for entrepreneurs whose businesses may not be making a profit, Stangler notes.

But small companies of all sizes face some of the same problems: the weak economy and the prospect of federal budget cuts. (Read more: Amid 'Fiscal Cliff' Stalemate, Main Street Deteriorates)

Stangler went into research at Kauffman after graduating from the University of Wisconsin-Madison law school in 2004. Ask him if he ever expects to have his own business, and he laughs, saying that his wife Katie, a pediatric nurse practitioner, is more likely to be the family entrepreneur, perhaps starting a crafts business.

Stangler spoke recently with The Associated Press as Congress was haggling about the fiscal cliff, the combination of billions of dollars in tax increases and budget cuts scheduled to go into effect Jan. 1. Economists have warned that if Congress doesn't prevent those tax increases and budget cuts from going into effect, the country will be at risk of going into a recession. And it's believed that small businesses would suffer the most.

Here are excerpts from the interview with Stangler, edited for clarity and brevity:

Q. How important is government policy for small business owners?

A. If you are a business owner, your primary concerns probably have to do with your business. Policy impacts at the margins but I still think that for most entrepreneurs and for most business owners, their top concerns are still customer demand, because consumer spending is still making its way back. Households are still deleveraging. Policy is very important, but getting sales, getting customers, running your business, dealing with employees probably still dominate the daily thinking of a lot of business owners. Policy obviously impacts that, but not always centrally.

When you do get into policy concerns that either are, could be, or should be at the top of a business owner's mind, I think tax policy is probably the biggest one because tax rates are about to go up and that's important because so many small business are taxed at personal income rates — like S corporations and sole proprietors.

There's a lot of disagreement in the literature, both academic and nonacademic research, about the impact of tax rates on business owners — how many businesses are actually subject to those rising individual tax rates. ... We worked with a company called on a survey of 6,000 businesses and individuals. One of the things our researchers dove into was the impact of taxes.

And we released a paper in October that said it's not necessarily the level of taxes (that's the problem). That doesn't matter, because no one expects to pay no tax. It's the sheer complexity of dealing with taxes. So it's not necessarily the rate, it's just the burden, the time burden, the money burden of compliance, and not knowing all the different kinds of taxes you're subject to. Depending on the type of business, you're going to have local taxes, municipal taxes, county fees, state, federal. Our tax code is just a continuing full employment act for accountants and lawyers. It obviously adds something to the economy, but it's also itself a tax on people who are trying to create other forms of wealth.

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Q. What is the biggest issue with the fiscal cliff?

A. The fiscal cliff is not only about the tax code. It's just the uncertainty. I know that's a catchall term that everyone uses, but it's for real this time. Everyone always says businesses hate to deal with uncertainty, and it kind of has a hollow ring to it because just the nature of running a business, you're always dealing with uncertainty. But at times like this, when politicians have manufactured a crisis, this is serious uncertainty, because no one knows how it's going to change. If we do go over the cliff, we're sort of going to get whipsawed because the Internal Revenue Service is preparing for the government going over the cliff, putting in place all the new tax forms, and then, six weeks later, when they reach a deal, we're going back to the way things were.That uncertainty and that expectation of being whipsawed back or forth is really a serious issue, whether or not you're worried about higher rates. It's just that hassle of dealing with all this.

Q. Is there any long-term damage done by this kind of situation to small business?

A. There are probably very few people, especially among the community of entrepreneurs and business owners and potential entrepreneurs now who would bet against the long-term strength of the U.S. economy. We've obviously got challenges. But there's very few people who would bet against the U.S. in the long term. That is borne out by the fact that we continue to see a strong level of entrepreneurial activity — people starting business. That act is itself a signal of optimism and confidence in the U.S. and its long-term growth.

Q. No matter how the cliff is resolved, it's expected that eventually, there will be billions of dollars in cuts to the federal budget? What will be the impact on small business?

A. It's probably finally dawning on lots of people, especially on the political right, what a large portion of the economy government spending is. In say, the 1960s, (a percentage of) government spending was what's called productive spending — the highway system, universities, infrastructure, and entitlements. What could be classified as consumptive spending — entitlements (like Social Security) then were a small share. Now it's radically different. Entitlements are a gigantic chunk and productive spending is really decreasing as a percentage of government spending. Nonetheless, that decreasing share of productive spending and even that consumptive spending on entitlements, that's still a massive chunk of the U.S. economy. And there are tons of U.S.businesses dependent on the government.

Inc. magazine every year does a list of the fastest growing companies. Government services dominated the list in the last decade. Washington D.C. is the top metro area for Inc. 500 companies since 2000. If a substantial of that is cut, you'll have a massive effect not just on small businesses, but innovative, fast-growing companies. History certainly shows that government spending, whether it was through contracts or through research grants or whatever, has certainly played a very important role in innovation and economic growth. National Institutes of Health-funded research at universities is hugely important. Small Business Innovation Research grants at federal agencies are hugely important. It's not simply the case that government spending equates with waste. It has its own role to play in an innovative economy.

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Q. What kind of chance does a young company have to sell a product or service to the government in this climate?

A. There are still government programs that mandate that a certain percentage of government contracts have to be given to small business. Those percentages are probably not going to go away. But it does mean the dollar amount probably declines. It's not just a federal issue. State government budgets have been seriously affected the last few years. They're getting healthier but they're certainly not back to where they could be or should be. It's probably increasingly hard.

Q. Is this a good time or a bad time for someone to start a company?

A. My own personal view is that it's never a bad time to start a company. There are good cases to be made that starting in an economic expansion is great because consumer demand is high and people will spend money. There's arguments to be made that starting in a downturn, whether it's a recession or a bear market or a sluggish recovery is also a good time.

If you're a tech startup for example,the demand for technology has been pretty constant the past few years. IPad sales went through roof at a time when the economy was deep in a recession.That's obviously a big company, but lots of other companies have glommed on to that heavy tech spending. There's also schools of thought that say if you start up in a recession, it's sort of a trial by fire. If you start up in hard times, and you survive, there's less competition and you come out of it stronger.

A few years ago, we did a count of Fortune 500 companies, and over half of them were founded either in recessions or bear markets. That's not simply a reflection of, well, they started in a recession, therefore they're better. I think it's a reflection of, if you have an idea or if you create an opportunity or if you'rein a university and you've stumbled across some discovery, there is that entrepreneurial drive ... and the macroeconomic environment doesn't matter if you come up with that idea. There's not necessarily a one-to-one corresponding relation between the macroeconomic environment and the demand for and supply of new ideas and innovation.

Q. Given what has happened in the economy the last five years, is it going to be harder to be a small business owner and expand your company in the next five to 10 years?

A. Yes, in some sectors. Take retail. There's the Walmart effect -- you've seen huge consolidation in retail. You've seen a huge consolidation in the information technology sector. We've sort of entered a "you eat or be eaten" atmosphere. Investment banks and especially the (stock) markets in the retail and information technology sectors simply aren't welcoming anymore toward small innovative companies. You either have to get big fast by being an acquirer or you have to be acquired.

Look at the employment distribution over the last 20 years. The percent of employment in giant companies -- those with 10,000 or more employees -- has risen and it's correspondingly falling in small businesses. That's obviously points toward something.

Q. Are you saying that the climate for small business is more hostile than it was?

A. It's not necessarily hostile. It depends on your company. If you're going to start a retail company, it's sort of hard to compete against Walmart. By the same token, in certain sectors — Internet, digital media, software — there has never been a better time to start a company. The supply of venture capital is outstandingly high. It's cheap, incredibly cheap, now to start a company in that sector.

You're seeing a squeeze on small companies in sectors like retail and restaurants, unless you're high-end, luxury, boutique kind of stuff.

At the same time, there's a potential flourishing,a best of times for entrepreneurs and small business. This is atransition and it's going to take some time to get there. We're sortof at the beginning of a new type of entrepreneurial rebirth insectors such as manufacturing in things such as artisanal products.