Fishman on coddling young industry.

Jay Fishman writing for Bloomberg View:

An obvious way to promote small business would be to reduce or entirely eliminate their taxes during the first three years of operation. While there are no reliable statistics showing how much in federal and state taxes new businesses pay, it is clear that taxes can be a burden on these enterprises. The average, profitable small business pays an effective tax rate of about 20 percent, according to a study commissioned by the U.S. Small Business Administration. Although many startups aren’t profitable in their initial years, those that are would be able to plow back earnings into their companies and, in turn, hire more workers.

This is an intriguing concept, but wouldn’t backwards induction render this ineffective? Firms know in year three that year four entails increased costs, and begin to provision for them. So in year two, they know that year three means provisioning for year four’s costs, and make provisions. So in year one, they make provisions for year two’s saving. This renders the temporary relief ineffectual.

To that end, I disagree with this part of Reihan Salam’s reaction:

firms that can survive during this incubation period might not be able to survive once they’re obliged to pay “big boy” taxes, so we’ll create firms that are essentially hothouse flowers.

I think this is possible, but I think it is more likely that only firms that can tough it out will do so regardless of the temporary relief. This is unless firms have an expectation that the government will intervene to extend relief beyond three years anyway if they begin to falter. That is certainly possible and would alter the incentives. The prospect of such discretionary handouts is also disturbing since we should be trying to move toward fairer tax policy. So count that risk against Fishman too.

But I do agree with this part of Salam’s reaction:

I’d much rather we embrace lower taxes and deregulation for all firms.

The best way to ensure firms respond appropriately to public policy is to make them believe the status quo has been permanently altered.

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