Against the backdrop of the financial crisis, with a bailout package that is as large as the cost of the Iraq war, economic policy emerges as the most important campaign issue for this election. The new American president will need to be extremely careful to not choke up the entrepreneurship engine with a tax policy that raises taxes to pay for the monstrous, ballooning deficit. I heard nothing, absolutely nothing last night from either candidate on where the jobs would come from, and I still think stimulating entrepreneurship is the only viable solution.
First, why is entrepreneurship important?
Here are some statistics about small businesses from the Small Business Administration (SBA):
* Represent 99.7 percent of all employer firms.
* Employ about half of all private sector employees.
* Pay more than 45 percent of total U.S. private payroll.
* Have generated 60 to 80 percent of net new jobs annually over the last decade.
* Create more than half of nonfarm private gross domestic product (GDP).
* Hire 40 percent of high-tech workers (such as scientists, engineers, and computer workers).
* Made up 97 percent of all identified exporters and produced 28.6 percent of the known export value in FY 2004.
* Small innovative firms produce 13 times more patents per employee than large patenting firms, and their patents are twice as likely as large firm patents to be among the one percent most cited.
I see entrepreneurship as the solution to most of the problems facing the American economy.
As you know, I believe in this so strongly that I have embarked on writing a series of books called Entrepreneur Journeys. I am hoping to demystify entrepreneurship and provide guidelines for creating a successful business that anyone can follow–as long as they’re willing to work hard, take risks and take ownership of their destiny. I have called entrepreneurship the weapon of mass reconstruction.
In my formula for creating a thriving small business system, the government does not need to do a whole lot. But it can do a few things that could add positive momentum to the process. So I’m making some tax policy recommendations that could really stimulate entrepreneurship.
There are four constituencies that we need to take into account in crafting an entrepreneurship-friendly tax policy: entrepreneurs, angel investors, venture capital firms and corporations. Let’s look at each separately.
My very strong recommendation to entrepreneurs is to learn the tricks of bootstrapped entrepreneurship so that they can retain maximum control over their destiny. This recommendation assumes that entrepreneurs would be putting their savings into their ventures. Thus, we need a tax policy that makes it as attractive as possible for entrepreneurs to “invest” in their own ventures, especially at the early stages. [See: “Bootstrap Yourself.”]
For example, an aspiring entrepreneur ought to be allowed to create a tax-free pool of income for use as personal venture capital. Such a pool of capital would go a long way to help kick-start new ventures.
To further help entrepreneurs, we also need to get rid of payroll taxes, which are unnecessary burdens imposed on fledgling and fragile companies. A lot of entrepreneurs don’t hire full-time staff because of the payroll tax burden, and this inhibits the creation of new jobs.
The next constituency is angel investors. These days, traditional venture capitalists hardly participate in early stage investments. The bulk of the responsibility of early stage investment is shouldered by angels, who are usually not the Bill Gates and Warren Buffetts of the world. (See “The Real VCs of Silicon Valley.”) More often than not, an angel turns out to be the entrepreneur’s uncle, who is a doctor making $400,000 a year and can afford to invest in the nephew’s audacious dream and unproven idea.
The misconception that the angels are the very rich people worth hundreds of millions leads people to think that these guys would invest anyway, taxes or not. But most entrepreneurs–especially first-time entrepreneurs–don’t have access to such high net worth people.
Thus, the government should be very careful how these $400,000-a-year uncles are treated from a tax policy point of view. The choice may well be between $250,000 being invested in a start-up, versus that $250,000 going into the government’s pocket as income tax.
Angels should also be allowed to create pools of tax-free capital for investing in start-ups–especially for unknown, unproven entrepreneurs who often don’t have access to venture capital. It is not so different from a tax-free account set aside for a child’s education. It is also similar to allocating money to “foundations” to fund nonprofit “causes.”
The third constituency is the venture capital firms. The expectation is that venture funds would take risks, fund innovation and essentially keep the entrepreneurship engine moving. In reality, venture funds have become lazy, risk-averse and interested only in later-stage investments. (See “Fund Envy.“)
Venture funds should have a tiered tax structure, whereby they pay lower capital gains taxes on investments in early stage companies and higher taxes on later stage deals. It is not dissimilar to the concept of long-term capital gains versus short-term capital gains, except those that take the risk of funding ventures with a 7- to 10-year horizon should have incentives to do so.
Finally, corporations can play a critical role in this equation. Venture capital funds only fund ideas that have the potential to become very large enterprises. However, the vitally important small business eco-system needs to have investors that fund smaller businesses. So, corporations that have a strategic stake could play the role of investor for this category of entrepreneurs.
As an example, let me point you to eBay (nasdaq: EBAY – news – people ). Many eBay millionaires came into existence as the e-commerce giant created an online marketplace for buying and selling goods. Even more entrepreneurial families making $100,000, $200,000 or even $300,000 off eBay transactions have created healthy, resilient lifestyles, while living the dream of self-employment.
Conceivably, eBay, Amazon and their ilk could even fund some of these small retail businesses if they were offered tax incentives to do so. Companies in other sectors could follow suit. SunPower (nasdaq: SPWR – news – people ) could fund solar farm entrepreneurs. Google (nasdaq: GOOG – news – people ) could fund online publishing start-ups. Whole Foods Market (nasdaq: WFMI – news – people ) could fund small fruit-juice makers.
And funding is not limited to technology start-ups: Businesses just need to have solid fundamentals. The policy nuances outlined above could have widespread impact throughout the economy and re-frame the American dream from a house, two cars and two beautiful children to self-employment and taking ownership of one’s destiny.
Done right, the entrepreneurship engine can create millions of jobs – white, blue and green jobs – and that, in turn, would increase the tax revenues needed to balance the deficit.