The Feehery Theory

To start a real economic recovery, look to startups

Posted on June 2, 2016

(Originally published in The Hill)

by Brian Robertson 

As hiring by temporary-worker staffing agencies has slowed to a crawl thus far in 2016, many experts are pointing to this slackening as a leading indicator of another labor market slowdown around the bend. That's unwelcome news, to say the least, in the midst of an economic recovery already characterized by weak growth and the sluggish creation of mostly low-wage, low-skill jobs.

The widespread dissatisfaction with this state of affairs has been manifest in the receptivity among primary voters in both parties to the argument that Washington has paid insufficient attention to the attrition of manufacturing industry jobs and the stagnation of wages that has contributed to the contraction of our once-vital middle class.

Whether one believes this to be an inevitable consequence of globalization or the result of an unwise devotion to self-defeating trade agreements, it is plainly the case that what has driven job growth in the United States so far in the 21st century has not been the manufacturing sector, but small business. Economist Peter Wallison of the American Enterprise Institute points out that almost two-thirds of net new jobs in the U.S. between 2002 and 2010 came from employment by small business, specifically startup businesses that are the engine of job creation and economic growth. One might logically assume, then, that the fact that new business startups continue at their lowest levels in over 30 years — with the number of firms being created about 30 percent lower than the average rate for the 1980s — would be a major cause of concern for policymakers.

One would be wrong. In fact, startups have gotten relatively little effective attention, for a whole host of reasons. First, advocating tax policy to encourage the creation of new business is less compelling as a political issue than focusing on job loss due to immigration or outsourcing. Second, both parties have their own ideologically driven reasons for finding the subject of spurring startups uncomfortable: For Democrats, the venture capital sector so vital to the success of new businesses is a convenient and frequent political target; for Republicans, the preferential treatment of startups in the tax code smacks of intrusion into the free market and the picking of winners and losers.

Both prejudices are misguided. The success of innovative new companies has become so important to economic growth and job creation that any attempt to reform the corporate tax code must make encouraging the creation of more U.S. companies a top priority. Recent studies have shown that existing targeted tax incentives for startups have largely failed because new and fledgling companies are limited in their ability to use tax deductions and credits because of limitations on using the losses they incur while getting established. Young startups often have to survive for years on investment capital while they develop a product or a service, which makes the investment environment crucial. But many business tax rules written with established companies in mind fail to acknowledge the unique challenges startups face that make things like reporting compliance and loss restrictions particularly burdensome. Debates over corporate tax reform should not lose sight of the vitally important question of how new proposals would foster the creation and affect the potential success of newly formed companies.

One policy element that poses political complications is the relationship between the tax rate on capital gains and the investment environment necessary to encourage the risk taking and capital formation startups depend on. The capital gains rate has already gone up, from 15 percent to 23.8 percent starting in 2013, and proposals are being floated in this campaign season to raise the tax rate on a long term capital gain to over 40 percent and to tax "carried interest" partnership capital gains as ordinary income. But the notion that such changes are only going to force the fat-cat vulture capitalists to pay their fair share omit to mention the crucial unintended consequence: Without a competitive capital gains tax rate and a meaningful differential between ordinary income rates and the cap gains rate, capital formation for new business development will be tough to come by, and those that will suffer will be the small aspiring entrepreneurs, not the Mitt Romneys of the world.

More positively, corporate tax reform that recognizes the essential role of new business formation in our economy will reduce unnecessary tax regulatory burdens for startups, let companies use the same accounting rules when they acquire startups that they are allowed to use for other acquisitions, and make the research and development (R&D) credit and other credits work for new businesses by providing them with a safe harbor from existing operating loss rules. In today's economy, giving a shot of adrenaline to startup companies is the best recipe for driving growth and creating the types of jobs, and small businesses, that are the model for future development.

Robertson is co-founder of The Common Trust, a nonprofit public policy group. He formerly served as policy director for Senate candidate Ed Gillespie’s 2014 campaign and was senior policy adviser for the Joint Economic Committee.