Ms. Diana Furchtgott-Roth
Senior Fellow, Manhattan Institute
Effects of Regulatory and Fiscal Uncertainty on Entrepreneurs
Senior Fellow, Manhattan Institute for Policy Research
Testimony before the Senate Committee on
Small Business and Entrepreneurship
November 29, 2012
Effects of Regulatory and Fiscal Uncertainty on Entrepreneurs
Senior Fellow, Manhattan Institute for Policy Research
Chair Landrieu, Ranking Member Snowe, members of the Committee, I am honored to be invited to testify before your Committee today on the subject of the effects of regulatory and fiscal uncertainty on employers.
I have followed and written about this and related issues for many years. Currently I am a senior fellow at the Manhattan Institute for Policy Research. I am the author of several books, most recently Regulating to Disaster: How Green Jobs Policies Are Damaging America’s Economy (Encounter Books, 2012). I am the editor of Overcoming Barriers to Entrepreneurship in the United States (Rowman and Littlefield, 2008).
From February 2003 until April 2005 I was chief economist at the U.S. Department of Labor. From 2001 until 2003 I served at the Council of Economic Advisers as chief of staff and special adviser. I have served as Deputy Executive Secretary of the Domestic Policy Council under President George H.W. Bush and as an economist on President Ronald Reagan’s Council of Economic Advisers.
The State of the Economy
The Great Recession ended in June 2009, but, over three years later, the economy still has not recovered. The annualized growth of gross domestic product is barely two percent. October’s unemployment rate stood at 7.9 percent, and 40 percent of the unemployed have been out of work for six months or more.
Labor Department data from the Job Openings and Labor Turnover Survey, released on November 6, show that employer job openings and hiring rates are still at low levels. The job openings rate in September was 2.6 percent, down from 3.2 percent in September 2007. The hiring rate in September was 3.1 percent, down from 3.3 percent in August. Five years ago, in September 2007, it was 3.7 percent.
The economy created only 171,000 jobs in October, following a revised 148,000 jobs in September. The civilian labor force participation rate is 63.8 percent, down from 64.1 percent in October 2011 and 65.8 percent in October 2007. This is the same level as in April 1983, at the beginning of the decade when millions of women moved into the labor force.
Despite all the people who have left the labor force, the unemployment rate remains unacceptably high at 7.9 percent. Over 12 million Americans were unemployed in October, and the percentage of the unemployed out of work for 27 weeks or longer stands at 40 percent. The Labor Department’s broadest measure of unemployment, including discouraged workers and those at work part-time for economic reasons is at 14.6 percent.
The 7.9 percent overall unemployment rate masks other groups within the economy that are doing far worse. The African American unemployment rate is 14.3 percent. Teens’ unemployment rates are even higher, at 23.7 percent, and the African American teen unemployment rate is 40.5 percent.
It is most troubling that although jobs are the first priority for most Americans, the Administration’s regulatory and legislative agenda has the effect of reducing jobs rather than creating them. The uncertainty of proposed tax increases, energy and environmental regulation, and the Affordable Care Act serve to drive jobs abroad rather than foster domestic growth.
The Role of Entrepreneurship
Syracuse University professor Carl Schramm and Bloomberg Government director of research Robert Litan, in a new book, Better Capitalism: Revewing the Entrepreneurial Strength of the American Economy, have calculated that the economy produces about 15 companies a year that will grow to earn $1 billion in revenue—the Googles, the Apples, the Yahoos. These companies were founded by entrepreneurs and grew to be giants, powering the economy.
If the number of such entrepreneurs could be raised to approximately 60 companies a year, GDP growth would rise by one percent, estimate Litan and Schramm, generating another $150 billion in output and reducing unemployment and deficits.
What stands in the way of the formation of these additional companies? What laws and government policies are preventing the next Microsoft and Ford Motor Company from getting off the ground?
The Uncertainty of the Fiscal Cliff
One drawback is the so-called fiscal cliff, which refers to the combination of spending cuts and tax increases that will occur on January 1, 2013, if Congress does nothing. Increasing taxes by $514 billion next year will make America less competitive and slow the economy. More entrepreneurs will be attracted by
offshore lower-tax locations, and those that remain will make fewer investments. Table 1 describes the tax changes that are due on January 1.
The Congressional Budget Office estimates that going off the fiscal cliff will reduce GDP growth in 2013 by half a percentage point, and that the unemployment rate will rise to over 9 percent. Ninety percent of households will face tax increases next year, according to the Brookings Institution-Urban Institute Tax Policy Center.
According to the Tax Foundation, at the upper end, a four-person household at median income in New Jersey would see a 7 percent increase in federal taxes of almost $7,000. Other states that would be hardest-hit include Maryland, Connecticut, and Massachusetts.
Businesses plan ahead, and Internal Revenue Service data show that 48 percent of small business income is taxed at the 35 percent individual rate. If the Bush tax cuts expire and the top tax rate rises to 42 percent, including the new Medicare tax and the phaseout of personal exemptions and itemized deductions, some businesses will cut back. They may delay expansion and investment and lay off workers.
The failure to pass a change in the alternative minimum tax for 2012 will have consequences for 2013 first-quarter growth. Without the fix, 28 million more people, including many entrepreneurs, will pay additional taxes under the AMT, a tax originally set up to catch high income earners but which now traps millions of middle-income earners as well.
Acting Internal Revenue Service Commissioner Steven Miller, in a letter to House Ways and Means ranking minority member Sander Levin (D-MI), reported that the IRS has programmed its computers in the expectation that Congress would adjust the AMT, as it has done in prior years. Reprogramming the computers would take months, and 60 million taxpayers would be unable to file returns or get refunds until late March.
Some of the most harmful effects of the fiscal cliff come from increases in taxes on capital, because capital investment allows entrepreneurs to expand and powers future growth. Raising long-term capital gains tax rates to a maximum of 24 percent from 15 percent means that people will postpone sales of capital assets in the hope that the rate will again decline. Raising taxes on dividends from 15 percent to a maximum of 43 percent will discourage firms from issuing dividends.
Taxes matter. If they did not matter, Congress could double them and get rid of the deficit. Taxes affect individual and business decisions. States with high taxes, such as New York and California, see that their residents migrate to low-tax states, such as Texas and Florida. Countries with high tax rates find they are unsustainable because capital is global.
Corporate tax reform would help entrepreneurs because it would attract capital back to the United States. America has the highest corporate tax rate in the industrialized world, at 35 percent, and, unlike most countries, corporations are taxed on their worldwide income. Both Republicans and Democrats have proposed lowering the top corporate tax rate. Further, the structure of the Research and Development tax credit needs to be modified, because it is of little use to start-up firms that have yet to make a profit.
Increasing Job Growth through Regulatory Reform
In addition to the fiscal cliff, numerous unpredictable regulations add to the costs of doing business and discourage entrepreneurship. Through regulatory reform, by executive action, President Obama could create more jobs without spending another dollar of taxpayer money, generating billions of additional dollars in income tax revenues for Treasury coffers.
Regulations are controlled by presidential appointees at agencies such as the Environmental Protection Agency and the Labor Department, which are part of the executive branch, and at “independent” agencies, such as the National Labor Relations Board and the Securities and Exchange Commission, which has quasi-judicial functions.
Tougher regulations lead to numerous economic woes, not least incentivizing employers to locate elsewhere. Friendlier regulations draw them back home.
Mr. Obama acknowledged this when, on January 18, 2011, he issued Executive Order 13563, entitled Improving Regulation and Regulatory Review.
Each agency is supposed to make a plan to “periodically review its existing significant regulations to determine whether any such regulations should be modified, streamlined, expanded, or repealed so as to make the agency's regulatory program more effective or less burdensome in achieving the regulatory objectives.”
On July 11, 2011, President Obama issued Executive Order 13579, extending this regulation to independent agencies.
While Mr. Obama knows that burdensome regulations crimp job creation, his agencies continue to interfere with private sector job creation.
The Environmental Protection Agency is set to release multiple regulations over the next few months. A prime target is coal, which accounts for 38 percent of American electricity production, down from 45 percent in 2010. EPA is developing regulations to restrict coal ash emitted into the atmosphere. It wants to impose tighter standards for mercury, nitrogen dioxide, sulfur dioxide, and other particulates, and new standards for water and carbon. It is considering regulations on hydrofracturing, potentially limiting the use of new-found inexpensive natural gas which can draw manufacturing back to America. EPA asserts that these more restrictive limits are necessary to protect public health.
Although these regulations might result in some small improvements in air quality, these regulations will raise the price of energy, discouraging energy-intensive manufacturing. The timing of these regulations appears unnecessarily harsh, especially because EPA states on its Web site that U.S. air quality has been steadily improving since 1980:
“Since 1980, nationwide air quality, measured at more than a thousand locations across the country, has improved significantly for all six principal pollutants. These common pollutants are ground-level ozone, particle pollution, nitrogen dioxide, carbon monoxide, sulfur dioxide, and lead.”
Furthermore, the links between improved air quality and health are unclear. At the same time as air quality has been improving, the incidence of asthma, a disease commonly associated with polluted air, has been increasing. Between 1980 and 2001, as measured air quality was improving, the prevalence of asthma tripled, according to the Centers for Disease Control.
EPA regulations have resulted in the closure of over 100 coal-fired power plants since January 2010. Although one stated reason for EPA’s regulations is to help the world’s climate, reducing American coal consumption does not help global climate change if that same coal is used in China.
The Affordable Care Act
Even though the Affordable Care Act’s taxes on small business do not take effect until 2014, the law is already affecting employment. Beginning January 1, 2014, companies that do not provide the right kind of health insurance will pay $2,000 per worker per year if they have more than 49 workers. Moving from 49 to 50
workers will cost a firm $40,000 per year (the first 30 workers being exempt from the penalty).
This law is especially expensive for small firms, many of whom do not already offer health insurance.
This requirement will cover employers with at least $500,000 in annual payroll costs, and it will add to employment costs for workplaces that do not now have the prescribed set of health benefits. Workers who are not laid off will receive lower wages to compensate for the higher benefits.
Unfortunately for employees, the Affordable Care Act encourages businesses to replace full-time workers with part-time workers, because firms do not pay the penalty on employees who work fewer than 30 hours per week. Several companies, especially in the leisure and hospitality business, have announced that they will be hiring more part-time workers. Income taxes on the most productive small businesses will increase, making them less willing to expand productions and employment. The top tax rate on business owners who pay taxes as individuals, not corporations, now is 35 percent. Under the new health care bill it will rise even higher, with the inclusion of an additional 0.9 percent Medicare tax on wage and salary income and a new 3.8 percent Medicare tax on investment income for singles and couples earning over $200,000 and $250,000 respectively. With state taxes, some combined rates will exceed 55 percent. That will discourage hiring and encourage retrenchment and use of contractors. Immigration
One reform that would help entrepreneurship would be to revise our immigration laws to admit more highly skilled immigrants and entrepreneurs, a goal that has been embraced by some Republicans and some Democrats.
Many people do not understand how immigrants could help create jobs. "Why give out more visas when we have a high unemployment rate?" is a typical question.
But data show that immigrants found new companies in America at greater rates than do native-born Americans. If America allowed more immigrants to enter, and gave green cards to those who created jobs, employment would rise.
Consider Sergey Brin's Google, Andrew Grove's Intel; Jerry Yang's Yahoo; Pierre Omidyar's eBay; and Elon Musk's PayPal and SpaceX, to name but a few. Past
immigrant founders include Alexander Graham Bell, Levi Strauss, Adolph Coors, and Henry Heinz.
Once companies are around five years old, they appear to reach a hiring equilibrium. They keep the workers they have already hired, but on average their employee expansion rate slows down and they generate no new jobs. One way to expand employment is to attract more new, innovative firms.
A bill sponsored by Massachusetts Democrat John Kerry and Indiana Republican Richard Lugar would set up a new class of visa called the EB-6, aimed especially at entrepreneurs.
Those who could bring in capital from abroad, or who have already generated U.S. sales, would be eligible for the visa. If they hired a certain number of non-family members, the EB-6 would transition into a green card, and they could stay forever and become citizens.
The Kerry-Lugar bill proposes about 5,000 EB-6 visas a year. Those immigrants who did not hire workers would not receive green cards and would have to leave. The Kerry-Lugar bill would allow America to take potential entrepreneurs on a provisionary basis, and keep the successful ones.
This visa would be especially attractive to some of the million immigrants in America who now have temporary H1-B visas, work permits obtained by employers that require workers eventually to return to their home countries. If H1-B visa holders could start companies and hire other workers, they could convert the H1-B visa to the EB-6, and then progress to the green card.
Once an H1-B visa was converted into an EB-6, one market for the new entrepreneur would be his former firm. Rather than selling his services to an employer, he would sell his firm's services to his former employer, and also to other employers.
Another group that could benefit from EB-6 visas would be the 60,000 foreign students who graduate with American degrees in the technical fields of science, technology, engineering, and math.
The possibility of such visas would encourage more foreign students to come here to study. Now, many do not come, because they believe that they will just have to return home when their studies are completed. Instead, they study elsewhere, for example in Canada, Britain, and Australia.
The uncertainty of the fiscal cliff and the administration’s legislative and regulatory agenda dampen economic growth and overall job creation. With this agenda, the economy will not produce the jobs needed to reduce unemployment, including long-term unemployment.
Table 1 : Tax Changes Taking Effect January 1, 2013 Tax Change Tax Increase (2013 over 2012) Expiration of the 2001-03 tax cuts (not including estate) $156 billion Expiration of the payroll tax holiday $125 billion Failure to patch the Alternative Minimum Tax $88 billion Expiration of business expensing $48 billion Expiration of other “tax extenders” $40 billion New PPACA (Obamacare) taxes $36 billion Expiration of the 2009 stimulus $11 billion Estate tax increase $10 billion Total, Tax Increases $514 billion Source: Tax Foundation; Congressional Budget Office; Joint Committee on Taxation; Office of Management & Budget.