Chapter 1.4 - WALL STREET & THE GREAT INVESTMENT MYTH

CHANGING AMERICA'S MIND Chapter 1 Part 4

Entrepreneurs and Real Investors
The Only Ones Who Should Get Tax Breaks

Small Businesses

When pundits and conservative politicians speak of the need for economic stimulus, particularly during a deep recession, they may grudgingly endorse (and sometimes even vote for) public works projects and maybe even extended unemployment benefits.  Both liberals and conservatives acknowledge that such measures can foster a short term increase in spending that will help temporarily.  More insistently, however, conservatives will advocate tax cuts as the means for longer term improvement and gains in employment. Liberals will agree with them when it comes to tax cuts for the middle class.  The presumption is that in hard times, they must spend this extra money on necessities thereby stimulating the economy.

Conservatives argue that the wealthy should also have the tax breaks because they will invest it in the markets which will spark more business spending and growth.  This is a supply side argument.  Both conservatives and liberals speak loosely about the importance of stimulating the private business sector as the means to create an increase in permanent jobs.  Both will also, in passing, mention the importance of small business in creating jobs, and may even point out that for the last decade, small businesses have produced almost 85% of all new jobs and currently employ over half of the workforce.  For the most part, though, most of the policies they adopt benefit mainly big multinational corporations and the financial markets. 

Coming out of the Great Recession of 2007 – 2008, with the earlier Bush tax cuts for the wealthy still in place, most of this business stimulus thus far enacted has benefited Wall Street firms.  It has also benefited Wal-Mart, as well as the Chinese firms that supply it.  The job growth that resulted (paid at slave wages) has been in China.  In spite of a 30% rebound on Wall Street, the Big Money private sector has, as of this writing(7/25,10), produced scarcely any new jobs in the US.  At the same time, small business has been deprived of needed funding for operations and growth.  As a result, the job gains in the US that have occurred resulted primarily from public works programs.  This is what loose thinking about tax cuts based on economic lies and myths gets us.

What if, instead, the politicians, including the conservative ones, actually provided an economic stimulus where it could make a clear and quick difference?  What if, they actually invested in the private small business sector instead of feeding the cancerous economic forces that caused the recession in the first place?  Since small business produces most of the new jobs, and since jobs are what are needed most, would this not make sense?

Let’s consider a simple example.  Imagine a small business owner who, even in this economy, has managed to pay herself a reasonable salary and still manage a net profit of $75, 000.  Let’s further assume that her tax rate is currently 25%.  Under that scenario, she will pay $18,750 in taxes, leaving her with $56,000.  Given the fact that her business is doing well, she will seriously consider adding an employee, but given payroll taxes and the high costs of benefits, this will be a squeeze.  Now let’s imagine that instead, the government gives her a 50% tax cut (approximately the tax cut that Big Money investments get through the capital gains tax), she would pay only $9,375, leaving her with $65,625.  With that amount, she will certainly add the new employee, and may even consider another part-time one.  If we cut her taxes to $5,000, the part-timer becomes a certainty as well.  But imagine that the government got really creative and gave small business a one-year tax holiday followed by the 50% tax cut.  Our successful small business entrepreneur will likely now take the risk to add two employees.  She won’t put her money into speculative things such as derivatives or the futures markets.


Startups

The other segment of our economy in which entrepreneurs and true investors occur, is in startup companies.  Starting a small business could be considered a startup, but mostly the term is reserved to describe new business ventures that require a fair amount of capital to develop to the point of making a profit.  Most frequently, such companies are technical, organized for the purpose of getting a new invention to the marketplace.  The new products usually require such steps as prototyping of the product, patenting, testing, making modifications, engineering, fabrication, marketing, and finally sales.  Startups often come about when an employee has an insight while working for a larger company and chooses to take the entrepreneurial risk of becoming self-employed in order to develop and own the new product.   Typically, after such entrepreneurs have used their savings and tapped out their credit cards, they need other investors to have enough capital to get all the way to the marketplace. 

There are two kinds of investors who put money into such start-up companies.  Angel investors enter early and provide funds at the riskiest stage.  When they do so, they have confidence that their assistance will make the crucial difference in the venture becoming a success.   They expect to earn a substantial return on their investment for this help, usually 30-50%.  They take an equity stock ownership position in the company and often either participate on the management team, or pay to add needed talent. 

As the new product reaches the point that its commercial potential is more evident, another infusion of capital is often needed.  People called venture capitalists provide that money, again in return for stock in the company.  This infusion of funds is scaled to be sufficient to get the company into the market place earning revenues.  If this works, at the point the company becomes profitable, and sometimes even before, the current owners (entrepreneur, angel, and VCs) determine that the venture has sufficient promise to offer the stock to the public.  This is the Initial Public Offering (IPO) referred to earlier in this chapter.  Such IPO’s are also the most common mechanism through which the angel investor and the venture capitalists achieve the desired return on their investments.

In a well managed IPO, the value of the stock increases overnight, sometimes doubling.  The Angel and the VC sell their stock in this public offering at a profit, hopefully one justifying their investment, and move on to the next venture.  The entrepreneur often also sells some shares so he/she can pay off credit cards and build up some savings again.  The substantial remaining proceeds from the sale of company stock go to fund the operation and growth of the company, usually creating numerous jobs.  

This is the kind of economic activity worthy of the word, “investment.”  Startups, along with small businesses, are the principal parts of the economy deserving the incentives of investment tax breaks.  Such incentives may also be productively used to encourage investment in developing new industries that can be beneficial to us all, like clean energy.  The tax breaks that currently fuel Wall Street speculation are nothing more nor less than a lobby generated form of legalized piracy!

Coming next:
What Other Wall Street Critics are Saying


Larry
Changing America's Mind is on Facebook