PROTECTING SMALL BUSINESS, PROMOTING ENTREPRENEURSHIP

Where Policy Needs to Go to Reinvigorate America’s Industrial Sector

By at 19 October, 2022, 12:55 pm

SMALL BUSINESS INSIDER

by Raymond J. Keating – 

The latest report from the Federal Reserve showed industrial production up solidly in September, with August’s reading being revised up as well.

Industrial production – i.e., the physical output, free from price changes, of the manufacturing, mining and utility sectors of our economy – grew by 0.4 percent in September. Also, the August reading was revised from -0.2 percent to -0.1 percent.

Manufacturing, which accounts for the largest chunk of industrial output, was up by 0.4 percent in September, and August was revised up from 0.1 percent to 0.4 percent.

Also, mining bounced back after being flat in August to growing by 0.6 percent.

So, as we look at a teetering economy, this was a welcome industrial production report. At the same time, as SBE Council has noted before, industrial production in the U.S., after long steady growth going back to 1919, has stagnated since 2007. Manufacturing production has been particularly stuck for the past 15 years.

At the same time, mining production, which includes oil and gas extraction, grew from post-World War II to the early 1980s; then suffered a gradual decline until roughly 2005; and has since grown strongly, though unevenly. It is important to note that the turnaround in mining output, that is, mainly in oil and gas, has been due to private sector entrepreneurship, investment and innovation leading to technological advancements in areas such as hydraulic fracturing and horizontal drilling. This is even more amazing considering that during the Obama and Biden administrations, energy policymaking had been and is overtly hostile to fossil fuels.

So, what to do on the policy front about an industrial sector that has stagnated recently, and therefore, suffered relative decline? First, we need to understand some basics about these sectors of our economy.

• Entrepreneurship and Small Business. Entrepreneurship always has been a central competitive advantage of the United States in all sectors of the economy, including in manufacturing and energy industries. Unfortunately, at best, entrepreneurship has stagnated over the past 15-plus years. (See SBE Council’s recent analysis titled “Resilient Fulltime Entrepreneurs During Pandemic: Sorting Through Data on Entrepreneurship.”)

For good measure, the U.S. economy is overwhelmingly a small business economy. For example, among employer firms, 98.1 percent have fewer than 100 employees, and 89.0 percent fewer than 20 employees (2019 latest data from U.S. Census Bureau). And this small business dominance can be found in the industrial sector. For example, in the oil and gas extraction sector, 95.6 percent of employer firms have fewer than 100 employees and 89.1 percent fewer than 20 employees; and in manufacturing, 93.1 percent of employer firms have fewer than 100 employees and 74.3 percent fewer than 20 employees.

• Private Investment. When focused on starting up and building businesses, on innovation, and on productivity, which are all essential across the economy, including regarding income and employment growth, investment and, therefore, investors, play essential roles. After all, entrepreneurs and businesses need financial capital to innovate and grow. And workers need that same investment in order to achieve productivity gains that are central to income growth.

• Opportunity. America has long been called “The Land of Opportunity.” At its core, that has meant that individuals willing to work hard and smart could make it, so to speak, in the U.S., and that was the case for individuals born here and those that arrived as immigrants. In today’s global market, technological advancements have expanded opportunity in terms of the mobility of capital and labor, and in terms of finding new suppliers, partners, and customers.

If we take these three economic essentials – that is, entrepreneurship and small business, private investment, and opportunity – which apply not just to industrial sectors but across the U.S. economy, and keep them at the center of economic policy decision-making, then such policymaking will be far more constructive. Indeed, when one keeps these critical matters in mind, policymaking turns away from non-productive undertakings that diminish the incentives and resources for starting up, building and investing in businesses, and for expanding opportunities.

So, what does a pro-entrepreneurship and small business, pro-investment, and pro-opportunity agenda look like for the industrial sector? It would include the following:

Less Government. First, it means turning away from the current costly policy agenda being pushed by the Biden administration and many in Congress in terms of higher taxes, more regulations, increased government spending, and protectionism on trade.

Pro-Growth Policies. Second, it’s not enough to simply stand pat on policy. Pro-growth measures are needed. On taxes, for example, changes are needed in terms of capital gains taxation, that is, the tax on the returns on investment in new, expanding and innovating businesses. President Biden has proposed increasing the top individual capital gains tax rate from 23.8 percent to 43.4 percent. But again, policy needs to go in the exact opposite direction. Given the economically destructive nature of the capital gains tax, the capital gains tax that makes the most economic sense would be 0 percent. Short of that, the capital gains tax should be at least cut in half, bringing the top rate down to 11.9 percent.

It’s also critical to keep in mind that capital gains are not indexed for inflation. Therefore, inflation increases the real capital gains tax rate higher than the stated nominal rate. And of course, during a period of high inflation, as we are currently suffering, the real capital gains tax climbs far higher.

Consider the simple example of a $100 investment returning $20 over two years. But what if inflation eats up $16 of that gain (an unfortunately reasonable assumption in this environment) ? Then the application of the nominal capital gains tax rate of 23.8 percent to that $20 gain translates into a real capital gains tax of 119 percent. Indeed, an investor could wind up paying a capital gains tax on a real capital loss.

It’s clear that as long as the capital gains tax is in existence, capital gains should be indexed for inflation.

Permanency for Sound Tax Policy. Third, the Tax Cuts and Jobs Act provided for full expensing of capital expenditures on short-lived assets (such as machinery and equipment). However, that will begin to be phased out at the end of this year (and phased out completely in 2026). Full expensing should be made permanent as an option for businesses, and it should cover all investments. By reducing the cost of capital, and making this a permanent option for businesses, this would be a clear encouragement to investment that enhances innovation, productivity, incomes and economic growth.

Access to Global Markets. Fourth, the U.S. needs to reverse course from the protectionism that has rested at the center of U.S. trade policy under Presidents Biden and Trump, and return to being a global leader in advancing free trade, that is, the reduction or elimination of governmental barriers – such as tariffs and quotas – that raise the costs of businesses being able to freely trade. Lower trade barriers benefit U.S. manufacturers, for example, by reducing the costs of inputs (keep in mind that nearly all imports are inputs to U.S. domestic businesses), and expanding opportunities to sell goods and services internationally.

Rein in Regulatory Burden and Overreach. Fifth, the Biden administration has been guilty of advancing a hyper-regulatory agenda across much of the U.S. economy, including high tech, pharmaceuticals, energy, labor-intensive sectors, independent contractors, and more, using expansive takes on regulatory power in such areas as antitrust, labor, the environment, and beyond.

Instead, an agenda needs to be implemented that limits regulatory overreach and activism, considers the full impact of new and existing regulations, and clarifies regulatory responsibilities and powers. Such a regulatory agenda would include sunsetting rules and regulations so that Congress is required to re-evaluate regulations after a certain period of time; congressional approval of rules and regulations to establish final responsibility for regulating with Congress; and improving analysis of regulations, such as by establishing independent regulatory analysis for Congress that would include subjecting regulations to rigorous cost-benefit analysis, whether for the consideration of regulatory legislation, or for purposes of evaluating existing rules and regulations.

These regulatory reforms arguably would be more important for sectors like manufacturing and energy, which tend to be heavily regulated, including by excessive and outdated regulations.

Finally, it is worth noting that this agenda would incentivize the supply-side of the economy, again such as entrepreneurship and investment, and therefore, not only would serve to spur economic growth, but by doing so be anti-inflationary. This kind of policy agenda would make sense no matter the current economic circumstances, but it is especially important during a period of stagflation, as is the case today.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His latest book is The Weekly Economist: 52 Quick Reads to Help You Think Like an Economist.

 

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