I meet every couple of months with a couple of small groups of diversified small businesses in the Southeast.

Here is what I am hearing.

Few are making any significant capital expenses.  Taxes are too high and conditions are too uncertain. These small businesses run with the purpose of minimizing a profit.  This means that they may rent a fancier office space than they would normally, furnish it nicer and buy more expensive company cars.  Why? Because this maximizes their benefit AFTER TAX.  They would rather spend $10,000 more on a company car than show the $10,000 on the bottom line and then give half of it to the government.

This is how small private companies think.  This is the opposite of the way public companies think.

This same thinking is exhibited in estate planning.  Consider a successful businessman in his fifties.  He has accumulated a net worth of roughly ten million dollars.  He is clearly well off but not private jet, Bentley driving, mansion occupying wealthy.  In fact most of these people drive their cars for several years , go to their children’s ball games and generally lived relatively modestly in order to grow their business.  They are generally not conspicuous consumers.

But looking at their position and thinking they may live another 30 years they realize that this comfortable cushion will double and triple with just modest investment returns, and that this will put them in a very high estate tax bracket.

They will set up trusts for their kids and their preferred charities, but they will still likely face significant estate taxes.  They are thinking that if they leave the financial assets to grow the government will benefit, not their family.  So they start to think like conspicuous consumers.  They will buy the expensive boat and tangible items like jewelry and collectibles that they can just hand to their children or family members.

At first they feel guilty, because they are not used to this way of thinking.  They have been used to postponing consumption and sacrificing to grow their business.  But when they realize that the alternative is to lose that money to government confiscation they quickly adapt.

Some think this is a good thing- that forcing them to spend their money is immediately stimulative to the economy, but that is very short sighted.  We benefit far more when they invest those funds in businesses that increase the GDP.  This not only creates jobs that are sorely needed, but it also creates the revenue stream that the government so desperately seeks.

During the 1970s inflation drove financial returns into higher tax brackets. Investors sought inflation protection in tangible assets.  When inflation was tamed in the 1980s this money flowed heavily back into financial assets and fueled the stock market boom and growth in the GDP for the next 25 years.

Today the problem is not inflation; it is the fear and reality of increasing taxes and stifling regulation.  Investment capital is going to less productive uses, driven by tax avoidance.

One businessman commented that the penalty for not buying health insurance is higher than the profit he currently generates per employee.  Alternatives in his competitive industry are few. His competitors with fewer than 50 employees, who do not have to comply with the health insurance requirement, will have a distinct advantage.  What an anti-growth policy!

Another commented that what was once a mistake in running a business is now a crime.  Whether it is immigration, environmental, health care compliance, or infinite state and federal regulations,  a business owner is assumed to be malicious in his intent and actions.  Fewer owners will want to take the risk of deploying their capital in illiquid small companies, only to be branded a criminal.

Larger businesses with big administrative staffs are better able to manage the regulatory maze.  Very small businesses with only a few employees can manage to stay off the grid.  But the businesses starting to require significant capital investment with 50 or more employees is bearing the brunt of the regulatory damage.  This has always been true to some extent but the increased regulatory burden has made this worse.  This is the economic sector that provides next year’s Apples, Dells and Fords- and most of the new jobs.

This has been the picture for four years, and even I get tired of small business people including myself whining about it.  Since the last election we have had to accept a realty that we wish was different. These small but successful business people will change their behavior even if they are not professional golfers from California.  The greater good, which the dominant leaders so promote, will suffer from the actions these small business people will take to minimize the damage from the policies of this administration.

In February I posted The Entrepreneurial Deficit – a collection of articles and comments on the absence of startups and it s long term impact on the economcy.

Glenn Harlan Reynolds, law professor and writer of the excellent blog Instapundit, expands on the theme in Where are the start-ups? in USA Today.

Excerpts:

In fact, it is yet another sign of a United States that is looking more like Europe: A society in which big businesses have cozy relationships with big government, while unemployment remains comparatively high. If you’re fortunate enough to have a job at one of those government-connected businesses, GE, for example, your situation is pretty good. If you’re a recent college graduate looking for work, your situation is not so great. If you’re a low-skilled worker, your situation is dreadful.

But I wonder if the biggest problem isn’t cultural. Since 2008, this country hasn’t celebrated achievement or entrepreneurialism. Instead, we’ve heard talk about the evils of the “1%” ” about the rapaciousness of capitalism, and the importance of spreading the wealth around. We’ve even heard that work in the public sector is somehow nobler than work in the private sector.

Countries where those attitudes prevail tend not to produce as much entrepreneurialism, so it’s perhaps no surprise that as those attitudes have gained ascendance among America’s political class and media elite, we’ve seen less entrepreneurialism here.

We hear a lot about the role of financial capital in economic development. But just as important — perhaps even more important — is the role of moral and intellectual capital. A country that celebrates achievement and risk-taking is likely to see more economic success than one that does not. And while the economy was lousy under Carter, there was less of this sort of anti-entrepreneurial talk.

HKO

We celebrate the accomplishments of government as if it is the same as the accomplishments of its citizens. It isn’t.

Moral and intellectual capital is less likely to rebound from a mere change in tax policy.  It would require a substantial change in the nature of the relationship between the government and the citizens.

 

FDIC Chairman Sheila Bair

When the preliminary results from the stress tests came back in mid-March, they matched what we had expected to see: Citi (even with its $45 billion in government capital) and a few others would be insolvent under the stress test assumptions. Citigroup still needed tens of billions of dollars’ more capital. However, if it raised that amount of additional capital, it would lose a very valuable tax break called a deferred tax asset (DTA). Citi could raise only a few billion more in additional capital before it would lose its DTA. That DTA was worth about $50 billion to Citi.

But as the Fed continued to review and refine the numbers, an interesting pattern emerged: the amount of capital Citigroup needed to pass the stress test was getting lower and lower. In fact, in some cases, the Fed and the OCC were using numbers regarding likely losses that were more optimistic than those of the better-managed banks. In one situation, they assumed losses would be only half of what one of the stronger banks was estimating.

The Fed and OCC decided to give the banks such as Citi credit if they planned to sell assets as a way to improve their capital ratios, even though the banks had no firm, legally enforceable agreements to sell them. Citi was also given special credit for its ring-fenced assets. And finally, the Fed and OCC made some very optimistic assumptions about Citi’s and other banks’ future earnings growth. The result: when the final stress test results were announced on May 7, lo and behold, Citi’s capital need was $5.5 billion—just below the amount it could raise without adverse tax consequences.

The total amount of capital required by the stress tests for all nineteen banks was $75 billion, $33.9 billion of that attributable to Bank of America, which was reeling from its overpriced purchases of Merrill Lynch and Countrywide. But the incongruous results for Citi stood out like a sore thumb. Indeed, Wells Fargo, one of the best-managed banks in the country, was told to raise $11.5 billion, twice as much as Citi. And much to our disappointment, the announcement of the stress test results did not include any firm commitments to review the managements and boards of directors of the institutions that needed to raise capital.

Excerpt From: Bair, Sheila. “Bull by the Horns.” Free Press. iBooks.

This material may be protected by copyright.

Check out this book on the iBookstore: https://itunes.apple.com/us/book/bull-by-the-horns/id477114443?mt=11 

HKO

Robert Rubin, Clinton’s Treasury Secretary, was instrumental in picking Vikram Pandit to be the CEO of  Citigroup.  Pandit took Citi down the path to catastrophe while Rubin watched from his board position.  Rubin was also a major fundraiser for Obama and instrumental in Tim Geithner’s and other appointment in the administration.  The special treatment of Citigroup was much more than merely suspicious.

David Stockman writes Sundown in America: How Crony Capitalism has Left Us State Wrecked  in the 4/1/13 New York Times.

Excerpts:

As the federal government and its central-bank sidekick, the Fed, have groped for one goal after another — smoothing out the business cycle, minimizing inflation and unemployment at the same time, rolling out a giant social insurance blanket, promoting homeownership, subsidizing medical care, propping up old industries (agriculture, automobiles) and fostering new ones (“clean” energy, biotechnology) and, above all, bailing out Wall Street — they have now succumbed to overload, overreach and outside capture by powerful interests. The modern Keynesian state is broke, paralyzed and mired in empty ritual incantations about stimulating “demand,” even as it fosters a mutant crony capitalism that periodically lavishes the top 1 percent with speculative windfalls.

for contrary opinions and comments on Stockman’s article: Economic Villains and Heroes  

“The attempt to turn strategy into a rigorous academic discipline has done considerable violence to the core value in almost all strategic thinking—the fundamental idea that one should always keep an eye on the big picture. Seeing the big picture means seeing not just what is, but what can be. It is, by its nature, a synthetic activity, not an analytic one. It is essentially creative, not reductive. It happens in an imperfectly knowable world, and it is risky. It is what we mean by entrepreneurial, in the best sense of the word. The academic discipline of strategy, like the business school system from which it emerges and the managerial perspective it represents, is fundamentally analytic, reductive, and risk-averse. By the default settings of all such institutions, it is bound to prepare people to become bureaucrats rather than entrepreneurs. We can nonetheless take some comfort in the knowledge that the core value of strategy will surely survive the academic onslaught.