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John Hood: Let’s foster more business

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John Hood

John Hood

RALEIGH — In today’s highly polarized climate, can we get our politicians to agree anything? Well, I can think of at least one proposition that attracts nearly universal assent: small business is the backbone of a thriving, broad-based economy.

I agree with it, myself, with some caveats. First, small businesses don’t exist in a separate universe from large ones. Many small firms are, in fact, highly dependent on the health of big corporations, for which they serve as contractors or vendors.

The second caveat is that when it comes to job creation specifically, small businesses play an outsized role not because of their size but because of their average age. It’s actually new companies that generate a disproportionate share of net new jobs. Many of them are small. But some small businesses never grow much. And some new firms that start out small keep growing rapidly even after they get large.

With all that having been said, politicians are right to stress the importance of small businesses and new enterprises. Unfortunately, they don’t always align their policy focus with their rhetoric. They chase big business “buffaloes” and concoct elaborate corporate-welfare schemes that have little relevance to entrepreneurs.

I’m pleased to report that in recent years, North Carolina policymakers have largely avoided this trap. The Republican-led General Assembly and the administration of former Gov. Pat McCrory focused on broad reforms of taxation, regulation, infrastructure, and education. While targeted corporate subsidies haven’t disappeared, they have diminished as a share of both the tax code and the political discourse.

The results are clear. The Small Business & Entrepreneurship Council produces an annual “Small Business Policy Index” that includes a variety of state and local variables. In 2012, North Carolina ranked 37th — dead last in the Southeast. We fared particularly poorly on measures of marginal tax rates and regulatory burdens. Beginning in 2013, state policymakers have worked hard to reduce those impediments. Now, according to the 2017 Small Business Policy Index, North Carolina ranks 14th in the country and 4th among the 12 Southeastern states.

But do these policy variables really influence business formation and growth? The answer is yes. Empirical research and common sense confirm that where the cost of starting and running new enterprises is higher, you’ll tend to find fewer of them than you otherwise would.

That doesn’t mean all the entrepreneurial action drains away from high-cost locations, of course. It just means that, everything else being equal, your local or state economy will fare better if you ease government’s burden on small and new businesses.

The latest entrepreneurship measures from the Kauffman Foundation confirm that North Carolina is doing well in this area. Among the 25 most-populous states, we ranked 8th in 2016 in both startup activity and in “growth entrepreneurship,” which measures how quickly those startups expand.

How can we boost our performance still more? One good idea would be to work on North Carolina’s capital-gains tax. The tax codes of the federal government and some states treat capital gains differently from other streams of income.

While wages are deductible to employers and then taxed when received by employees, capital gains get taxed in multiple ways — first by taxes on the money to be invested, then by taxes on corporate income, and then when the capital gain is realized.

North Carolina ranks 31st in its tax rate on capital gains. A simple way to move up the rankings would be to follow the lead of South Carolina. While its personal income tax rate of 7 percent is higher than our 5.49 percent, its tax rate on long-term capital gains is only 3.9 percent, ranking it 16th. That’s because it allows taxpayers to exclude some of their capital gains from taxable income.

We could do that, too. Lawmakers could even phase the exclusion in slowly over time if they wish. By reducing the tax bias against capital formation, we would make it more attractive to start or invest in new companies in North Carolina. Can I get an amen?

John Hood is chairman of the John Locke Foundation and appears on the talk show “NC SPIN.” You can follow him @JohnHoodNC.

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