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07 March 2010
Jobs For All
All net new jobs are created by small businesses. This is a mantra which is
regularly intoned by economists of all stripes, and it is backed up by shoals
of economic studies. Even politicians know it to be true. The problem then is,
how do you construct policies that will help small business to continue this
miracle of conjuring work from air? But even asking the question is wrong, and
that's where it all goes pear-shaped.
Keynes, the famous Keynes, talked about animal spirits, although not in this
context, and believe me, an illegal immigrant in Wolverhampton, Albuquerque
or Paris struggling to feed his wife and three children by selling Italian-produced
Chinese shoes in street markets does not want or need any help from the State,
he just wants it to get out of the way. Of course he doesn't pay taxes, have
a bank account, or create any other trace which could lead 'them' to find him.
He relies upon the support network of his fellows. But oh boy, does he create
jobs! And he consumes, and saves, and educates his children for all he is worth.
Unfortunately politicians, and even many economists, think they have to interfere
in the small business sector to make it work better, partly out of genuine concern
and partly - especially before elections - out of self-interest. So they exempt
new hires from payroll tax (the US, last week, but the worker must have been
unemployed for at least 60 days), or they offer loans to cash-strapped small
businesses (Spain, last week, but it's just a proposal which might be agreed
in principle by May, and will be operated through the Official Credit Institute),
or they offer tax deductions for capital expenditure (almost all countries).
All such schemes are highly bureaucratic and involve the small business concerned
in a clammy embrace with government which distracts it from its real job of
making profit and leads to a long tail of paperwork, inspections and accounting
costs. These schemes also carry a big load of moral hazard: if the government
will pay you for spending money on buying laboratory equipment, you will classify
everything under the sun in that way, so that an inspector has to crawl all
over your accounts to check that you are not cheating. And one can say, cruelly,
that if a small business needs to borrow money from the government then it is
best off bankrupt, so that the owner can dust herself off and start again.
What is really needed by small businesses in such times, apart from the best
ones, which government will never see, can be divined from the pleas of small
business support organizations. The UK's Federation of Small Businesses is begging
government not to apply its new social security tax hike to its members, accurately
calling it a 'tax on jobs'. The Irish Irish Small and Medium Enterprises Association
says that labour costs in a multinational represent 8% of total expenses, while
in a small business the figure is 48%.
As a generalization, it is the bloated state of the public sector which crucifies
small businesses, both directly through legalistic and bureaucratic interference,
which costs time and imposes pettifogging rules (your illegal immigrant laughs
at the idea of an 8-hour day and maternity leave), and indirectly through the
need to pay for the hordes of useless civil servants via income tax and social
security charges.
What then can be done, with the confines of a legitimate and caring society,
to help small business? Turn a blind eye to the immigrants, even encourage them,
and take the resulting social problems on the chin; they are probably the single
most helpful prop to the forward growth of the economy if they are allowed to
work in sufficient numbers. They will soon emerge into the light and become
upstanding tax-payers, if you give them a chance. Create highly tax-privileged
regimes for small business by taxing turnover at a low, set rate, and abandoning
the whole paraphernalia of VAT, sales taxes, income tax, social taxes, property
tax and the rest, until the firm in question reaches a critical size at which
it can afford to join the standard tax regime. This is done quite successfully
in many Eastern European countries; but the EU doesn't like it, being against
competition. The EU is also against free zones, which is just dotty. Exporting
is widely acknowledged to be just about the the most beneficial economic activity
there is: what is wrong with creating free zones near airports, ports and major
motorways where no-tax or low-tax regimes could be offered to small companies?
And finally, or perhaps first, de-bureaucratize the whole process of starting
and running a small business. Employees of small businesses should be allowed
to make their own tax returns, which will do more than anything to provide cash
flow to businesses; OK, some of them will be feckless or will cheat, but so
what? Eventually it will catch up with them.
Of course there are entrenched vested interests which will prevent any of this
from happening; that's why China grows at 8% and Europe managed 0.1% at the
end of 2009. And so it will continue; just thought you'd like to know why! But
humans and their animal spirits are the same everywhere; only give them a chance, and you'll be amazed at what they accomplish.
You have been
reading an entry on the following blog:
UK Chancellor George Osborne has unveiled plans for a new Office of Tax Simplification.
The UK tax code - a somewhat amorphous concept since what is included depends
on what you choose to call a tax - is said to be around 30,000 pages long. Again
that begs the question of what you call a page, what size type, how many lines
etc etc. Anyway, no-one questions that there is too much tax legislation, and
every annual Finance Act adds another thousand pages or so. Even tax practitioners,
who you would think might benefit from complex tax legislation, are complaining
that it has become impossible to answer straightforward questions from their
clients. And the Inland Revenue has taken to making up the rules as it goes
along, for instance on tax residence, probably thinking to itself that since
no-one knows what the law actually says any more, it may as well use whatever
interpretation suits its purposes, which, surprise, surprise, is usually to
extract more tax.
The UK is not alone in having an overgrown tax code. In the USA, no-one even
seems to know how long the Tax Code really is. It has capital letters because
unlike in the UK, there is something called the Tax Code, and you can even buy
a printed copy of it from the government for a mere thousand dollars. President
George W Bush said: "The tax code is a complicated mess. You realize, it's
a million pages long." Most estimates though are down in the tens of thousands
of pages. One of the problems in the United States is that Congress quite frequently
tacks tax legislation on to other bills, being very often the only way of getting
it through. Then of course there is State-level tax legislation as well.
For there to be any chance of simplifying and shortening the tax code in an
advanced country like the US, the UK, France or Germany, you would first of
all have to understand why tax legislation grows like Topsy, and the answer,
inconveniently, lies in the word 'Democracy', ably assisted by public choice
theory. Getting and keeping political power nowadays means taking the part of
the innumerable groups, factions and interests that make up your constituency,
whether that be a small patch of countryside (for a local councillor) or a whole
nation (for the leader of a national political party). And the first thing that
any group wants from its politicians is to pay less tax, whether the group is
the motoring public, cyclists, commuters, train motormen (sorry, motorpersons),
car manufacturers, gas station operators or bus companies.
And in that microcosm of just one part of human life (getting to work) you
can immediately see the problem: these seven constituencies have conflicting
interests from a fiscal perspective. Some people belong to more than one of
those groups, as well. It's impossible to optimize a tax system to please everyone
all the time; the best you can do is to please some of the people some of the
time. But that doesn't stop politicians from trying. In the USA, where the system
is best developed (and the tax code is longest) the game is famously played
with 'pork', or 'earmarks', the little add-ons to a bill in progress that secure
the votes of enough legislators to get the bill through. Then it has to go to
the other House, and perhaps back again, each time gaining more weight. Certainly
you could never have a saying in the USA that 'a rolling bill gathers no pork'.
What is to be done, then? Abolish democracy? As Winston Churchill said: 'Democracy
is a very bad system. But all the others are worse.' No, we can't do that. So
what we do is to invent new quangos called The Office of Tax Simplification
or similar. Both Bush presidents did it; so did Bill Clinton. The only reason
that President Obama hasn't done it yet is that he has been too busy making
the Tax Code longer. Just give him time.
Reducing the number of countries would work, in terms of reducing the total
amount of tax legislation, and possibly the total number of tax lawyers. The
Romans proved that; but empire-building has become unfashionable lately. In
fact it's going in the opposite direction: in the UK, regions like Scotland,
Wales and Northern Ireland are all becoming more rather than less independent,
and along with that independence goes tax-raising and spending power, with,
yes, you guessed it, brand new regional tax codes.
Flat taxes work, too, and are even efficient at optimizing tax-gathering; but
they are a non-starter in advanced democracies. The new, Eastern European members
of the European Union got away with introducing them ten years ago because clever
Harvard-trained economists slipped them through before domestic politicians
had cottoned on to the usefulness of a bulky tax code. They are learning quickly,
now, and one by one the countries with flat taxes are undermining or abandoning
them.
So there it is: fat tax codes go along with fat people as shining achievements
of our civilization. You'll just have to learn to love them.
So here I am, in January 2011, the 25-year-old scion of an august European banking
family based in London, fresh out of Harvard Business School, and my Dad, who
is still Chairman, wants me to get some hands-on experience of actually running
a business before he steps down in a few years' time. So he's putting up USD100m
as start-up capital and he is suggesting I specialize in family offices (that's
the name given to investment management partnerships which look after the wealth
of individual families). It's an area we've never majored in, and Dad thinks
we ought to get it going. I can't disagree with that; it's probably been the
fastest-growing sector of wealth management in the last ten years, and we're
missing out big time.
Although the firm has its HQ in London, we also have substantial capital and
offices in New York and Zurich, and of course we have branches all over the
place. So Dad's first question to me (and my first
question to myself) is: "Where are you going to put the firm?"
The criteria must include:
Good communications, not just in terms of telecoms, but also good airline
connections, because clients are going to want to visit us.
Availability of qualified staff.
A good tax environment for investment purposes; we aim to have at least
several billion under management within a few years.
Now of course we could separate the sales side, the meeting and greeting, from
the investment management. But clients don't like that very much: they want
to look into the eyes of the person they are going to trust with half a billion
dollars of their wealth. So in the end, the choice of HQ cities is quite limited.
London, and New York, perfect as they are for meeting clients (and I would
have all the advantages of our existing offices and support services) can be
ruled out straightaway. The US Restoring American Financial Stability Act has put
a strait-jacket around banking operations and staff remuneration, and in Europe
the Capital Requirements Directive is even worse. No-one wants to work under
those sorts of rules, and no bank would willingly submit itself to legislation
which will double or treble the amount of capital you have to hold. Dad says
that if he wasn't already near retirement he'd move the whole operation lock,
stock and barrel to Hong Kong or possibly Zurich. And he says that there isn't
a senior banker in Europe or America who isn't asking himself the same questions.
Zurich is possible. The problem is that Switzerland is locked into a deadly
embrace with the EU, and little by little all its financial freedoms are being
whittled away. After what happened with UBS and its US clients it's a tough
sell to persuade clients into Zurich if they're not already there, and then
they're probably locked up with someone else.
So, a bit reluctantly, because of the life-style, I have to decide against
Europe. There are one or two outliers, Canada for instance, which hasn't (yet)
given in to the G20's demands. Toronto isn't a bad place to be. Then there are
the big International Financial Centres (not allowed to call them 'offshore'
any more!) like Panama, Cayman and Jersey. We'll use them, of course, for fund
management, but the skill pools are quite limited and they are ruled out on
travel grounds. They have something called fog in Jersey, and you've got the
EU breathing down your neck.
So in the end it's a no-brainer, and it's called Hong Kong. Low or no tax,
plenty of banking professionals, good connections, and right next door to the
biggest source of new wealth that there is.
"Of course," said Dad. "I knew that would be the answer, but
you had to think it through for yourself." He reflected a moment: "It's
a pity the European Parliament and the Congress didn't go through the same thought
process. As it is, they've signed a collective death warrant for their financial
sectors. Politicians!"
As he talked, I was looking for Mandarin lessons on my Blackberry.
Penelope Wise
Penny Wise but not Pound Foolish! But remember: I am not offering investment advice. My comments are just for your general information; I do not recommend investments, and you should take professional advice before entering any investment contract.
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