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Someone has to pay

My friend, Angelo Santinelli, posted today about the Death of Incentive.  Angelo is rightly concerned about the increasing tax burden on entrepreneurs which may dissuade some from taking the risk of starting a new business.  Angelo was nice enough to ask for my thoughts on his post before it was finished and incorporated some of my thoughts in his final draft.

However, while I sympathize with Angelo's position and agree that we need to stimulate entrepreneurship and innovation as a way to revive our economy, I also worry about how our government can get back to a balanced budget.

It's well documented that Clinton left office with a large budget surplus.  Of course, this was also during the height of a huge economic bubble.  Bush had the bad luck of an economy that was certain to come back down to earth, followed by the further negative impact of the September 11 tragedy.  I can't blame Bush for these facts which, on their own, would probaby push the government budget surplus into a deficit.

However, Bush also pushed though big tax cuts, launched a couple of expensive wars, and provided no check on increased government spending.  A new financial crisis at the end of his terms has left Obama with unprecedented deficits with the spectre of a necessary financial stimulus piling on even more debt.  I remember when a $175B deficit was a big number.  This year, our deficit is TEN TIMES that at $1.75 TRILLION. 

I hate unbalanced budgets.  It's fiscally irresponsible and puts off the inevitable reckoning.  I agree that during these times of crisis, we need to run a deficit.  And, we can afford a certain level of deficit spending.  Maybe we can even afford a $1.75T deficit for this year.  But, we need to be on the path of balancing the budget.

Obama is saying that the deficit will be cut in half in four years.  But, cut in half from this year's number is nowhere near good enough.  That's still an $875B deficit.  We have to narrow the deficit much more than that within four years.

I am sure that Angelo and I agree that Obama is proposing to spend too much.  I am very sympathetic to Obama's priorities.  I'd love to spend the money he's proposing.  But, right now, we can't afford it all.  If we can't afford it, we shouldn't spend it.  I'd like to more drastically cut the deficit over the next four years.  I'd get half of it back by lowering the spending targets.  And, I'd get the other half back by raising taxes.

This is where Angelo and I don't agree.  No one likes paying taxes.  And, I've certainly paid my share.  But, I am still very well off, luckily.  I don't think that the tax rates deterred me from being an entrepreneur or a VC.  You have to make a lot of money to pay a lot of taxes.  And, it's only those who are relatively well off that can pay more taxes so we can lower our deficit.  As long as were really careful on spending, I'll be willing to do my share to pay some more taxes.  I agree that radically higher tax rates would be a deterrent.  We can't return to the 70% marginal rates that Reagan eliminated.  But, anyone who rails against a certain tax hike should have to propose some other tax hike in their place until we get our deficit under control.

I'd like to give Obama the target of getting the deficit down to $200B within four years.  This is still a big number, except in the context of the big Bush-era deficits.  Then, we should get to a surplus two years after that.  And, we may need to run a surplus for a while to pay off all the debt we've racked up in the interim.

One thing I do think, however, is that all Americans should have a bit of pain to get our budget balanced.  I don't want to raise the taxes much on the middle class, but they should pay a bit more.  If they had a $100 surcharge on their taxes for the year, they'd be part of the solution.  We're all going to have to sacrifice something to get our fiscal house in order.  All but the poorest of us can live more economically in some way.  Let's all pitch in, pay our share, and get back to fiscal sanity.

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Comments

Sarah,
Thanks for your comment. You and I are in agreement. Although extremely high tax rates may really diminish entrepreneurship (or many other business activities), a few points won't make a difference. I think that entrepreneurs are motivated by all the things you say. Some do it mostly for the money, but most do it as part of a passion to make an impact. It's that direct link between action and impact that motivates most start-up activity, by the founders and employees.

Mike, I'm a little late finding this post, but I wanted to emphasize a point that you only touched on in your response to Angelo.

The question, for me, is really what does stimulate an individual or a group of individuals to start their own business? Is it the desire for independence, a combination of knowing the right people at the right time, a passion for an idea, being surrounded by a culture that supports and drives innovation and fosters the connections necessary to put all the pieces of the puzzle together? Or is it the rate of tax?

Whilst policy has an important part to play in driving an economy and its competitiveness, I don't believe policy starts companies. When I look at the concentration of entrepreneurship in key areas around the United States, I see the primacy of culture and an enabling environment that is people and network driven.

To be frank, I just don't think there are many people sitting at home, sitting on an idea and thinking "well if only tax rates were a little lower, then I'd do it."

I'm not suggesting that means there should be a free-for-all on taxes to get the US back to a balanced budget. I agree with Angelo that "I have an extremely difficult time understanding how the recent tax proposals will spur innovation and entrepreneurial job creation" - they probably won't, but they probably won't hinder it either.

Mike -

I agree more with Angelo on this one. The problem here I think is one of opportunity cost. Raising taxes on someone who makes >$200k (or whatever the actual amount is) in a year only looks at that year. But most small businesses start scratching out next to nothing for a number of years. The greater income down the road makes up for the opportunity cost of a salary they could've gotten in the meantime (as well as the savings/investing compounding they would've gotten over those years).

Automatically characterizing those who make that much in a given year as "well off" is mistaken (as is categorizing VC's as entrepreneurs (though they might have been at one point - they're professional investors)). It's as bad as thinking myself poor because I'm in the 15% tax bracket for 2008 for voluntarily staying out of the salary workforce.

The main problem is that the earnings of an entrepreneur are more "bursty" than salary, and probably back-end loaded. We're not talking about the next 20 year-old who makes the next Facebook - this is the person who starts a pizza place, coffee shop, laundromat, what-have-you. That type of entrepreneur spent years making next to nothing, and then once they start making the money that makes up for that we want to take more away.

The problem here isn't just a question of property rights and morality, but pragmatic. If you raise the taxes on the back-end like that, you lengthen the time that it'll take to be made whole on the venture. That changes the whole calculus of the risk assessment. It means more people wanting to stay with steady salary jobs instead of taking the risk of starting their own business. Which of course means a less dynamic economy. I had read that raising taxes equivalent of 1% of GDP can lower real GDP by 2% to 3%. I think this type of dynamic is why.

You're right that it won't put much damper on the type of entrepreneur that you've had access to (the high-tech guy), but that is a small slice of the entrepreneur pie.

The other part of the problem with the "tax the rich more" idea, is not just one specific rise or another, but the fact that it speaks to a more general theme. Would I start a (non-high-tech) business in an atmosphere where I think not only is there about to be an increase on the taxes I'll pay someday when I actually make money (therefore increasing my opportunity cost), but that by the time I get there it'll be even higher still (increasing my opportunity cost even more by an unknown amount)?

The other part you mention, spending, is where the real problem is. From what I've read, non-defense government spending since the 80's has been in the 16.5% of GDP range. With the "stimulus" that is going to be something like 23% of GDP this year. And after the stimulus is over, it'll still be in the 19% of GDP range, apparently at a 25% increase since the late Clinton years.

Case in point: Obama claims that they'll identify programs that aren't working and stop them. How about the Dept. of Education? Look at the state of education in this country over the life of the DOE. Instead of recognizing this failing institution, the push is instead to increase federalization of public schools.

War on Drugs? How much does that cost us per year, and at what societal costs?

The future is not looking very bright from where I'm looking. I'm in the minority, but I think the government is going in exactly the wrong direction. To be clear, it's the same wrong direction the previous administration had us pointed.

- Rich

Mike, As always I appreciate your thoughts. I think that you and I agree on more than we probably disagree on. Which means that either we've both moved to the middle as we've gotten older, or one of us is moving closer to the others side :)

I am concerned about the deficit. However, before we go and create a slew of new mandates, why don't we pause and see if the mandates that exist are even effective. The government is very adept at creating new programs. What they are terrible at is running programs effectively and efficiently. So why doesn't Uncle Sam try a little business process re-engineering on itself. Lets cut the waste and find some saving before we increase taxes and propose spending on project with questionable merit. This is why I am in favor of sunsetting new laws and programs. This would force Congress back to the drawing board to see if things are working as assumed and make adjustments. I also agree that everyone should share the pain of getting our country back on its feet. But lets start by making certain that we aren't throwing good money for poorly designed programs that fail to meet their objectives.

It is evident that we are moving toward socialism, or social democracy, but lets remember what Margaret Thatcher warned - eventually you run out of people who pay for all the social programs. Lets ALL pitch in and lets rebuild the America that attracts people from around the world who come here for opportunity, not a hand out.

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