Wednesday, October 26, 2011

Have We Lost Our Ambitions or Our Incentives?

"We have lost our ambition, our imagination, and our willingness to do the things that built the Golden Gate Bridge." 

The above quote came from president obama on Tuesday.  I can't exactly claim to be surprised.  I've chronicled pretty well my impressions of his takes on personal responsibility.  To me, this is yet another attempt to deflect.  Here he wants to blame the failings of 2 generations of elected governments to the individual doers and builders of this country. 

Let me be clear.  The innovative spirit of this country is being buried by a morass of burdensome regulations and the rewards are being confiscated faster than ever before in our nation's history.  First the government makes it too hard to innovate and then they confiscate the rewards for the risks you take. 

Let's dig into this a little further. 

First, how are regulations effecting innovation? 

Let's start with existing companies.  A cross industry survey of 44 medium to large businesses found that the total cost of compliance on data and privacy issues averaged at $3.5 million per year.  This cost was only marginally related to the number of customers meaning that a majority of the costs are fixed.  These fixed costs would also apply to startup businesses, but we'll get back to those.  Depending on the industry you're also faced with environmental costs, including doing very expensive impact studies on each and every project.  These can take months to complete and years to approve.  For public companies, SEC compliance issues are a major cost, averaging $2 million or better each year.  Banks are only beginning to discover the high cost of compliance with Dodd Frank authorized regulations, but the expected costs range from low estimates of $3 million to highs of $10 million per company per year.  As we've previously discussed, these costs while high, are easily absorbed by mega-banks, but will crush small local and regional banks.  Purely from an economic standpoint, these regulations remove money from budgets that could have been reinvested in new ventures, new R&D, and new exploration.

Then you have the perceived costs of non-compliance.  This threat of fines for violating little understood and poorly worded regulation prevents many firms from innovating the delivery of products and services for fear of unknowingly running afoul of an unforeseen regulation.  Typically most firms do not pursue new lines of business for several months or years after new regulations come out, simply to wait and see how they are applied and interpreted.  With the volume of regulations rising exponentially, these delays are becoming longer and more widespread.  Some very prominent businessmen have expressed their fear of the level of uncertainty the current regulatory climate creates.

Now, let's take a look at startups.  These innovators can be anything from a new corner store, to a company that developed the proverbial better mousetrap.  In 2004 the Small Business Administration's Office of Advocacy commissioned a study that showed the average costs of regulatory compliance for small firms was $7,300 per employee per year.  This was 7 years ago and well before the recent onslaught of new regulations.  When starting a new business or just expanding it out of your garage eats up the majority of your margin, are you really going to take that step?  For many, today, the answer appears to be no.

For those that do expand and innovate, for those that overcome the regulatory burden or risk it's interpretation, what is the reward?  Just with federal income taxes you are faced with confiscation of up to 35% on corporate earnings, then taxed again on dividends up to 15%.  If you elect flow thru taxation, that is, treating all corporate income as personal income, then you pay a top marginal rate of 35%.  Then there's your social security tax.  This amounts to up to 15% of your gross.  If you employ others you're responsible for a portion of their social security and medicare taxes as well.  Factoring in state and local taxes, you could lose 45-50% of your profits just for the right to exist. 

What are you risking your future on?  You can be safe in a job, safer if it's a government job that never goes away or you can risk yourself for half of what you earn.  Oh, and you can't earn nearly as much as you should because you've got to take on these compliance costs. 

So, my question for the president:  Have we really lost our willingness to be great or have you and the monstrosity of a federal government bound our hands in red tape and taken the shirts off our backs to pay for it?

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