oftwominds-Charles Hugh Smith

Trends for 2009: The Death-Spiral of Local Government and Small Business

December 29, 2008

State and local governments are responding to shortfalls in tax revenues and spiraling pension costs by raising "fees" (a.k.a. taxes or junk fees) just as the backbone of the economy--small business--is struggling for survival. The more government employees demand "what was promised" in pensions, the more small businesses will fold, cutting government revenues in a death-spiral with only one end: state, county and city insolvency.

I am starting a new series today entitled "Trends for 2009" which will attempt to describe those trends which will be working beneath the MSM-induced "everything's gonna return to 2007 real soon" fantasy.

Let's start with the death-spiral of state and local governments raising taxes and fees to offset their collapsing tax revenues.

Contrary to the illusion created by glossy adverts and a corporate-owned MSM (mainstream media), huge global corporations are not the primary provider of jobs and taxes in the U.S.--that role is filled by small business, which also provides roughly 80% of the job creation and innovation in the economy.

The MSM tries to make a distinction between "marginal small businesses" and "small business," but all small enterprises are marginal in our high-overhead, high-tax, high-fixed cost economy. So guess what happens as revenues decline but fixed costs (rent, business license fees, utilities, health insurance, etc. etc.) stay high? Small businesses will close en masse.

Slump Batters Small Business, Threatening Owners' Dreams (WSJ)

Now put these two together: higher taxes/fees and small businesses on the precipice. Welcome to "death spiral 2009" in which public employee union demands for higher taxes to pay their bloated pension and healthcare benefits will kill off an ever-rising number of small businesses, further depressing tax revenues.

Note to politicos, government managers, public employees and their unions: we don't have to keep our door open. You seem to think we do, but we don't. When we can't pay ourselves and/or we get tired of the endless stress and grind of all your regulations and taxes and fees, then we'll close our doors and issue a big sigh of relief. We'll make do somehow without employees, storefronts, offices, permits, and all the other sources of income you, our governments' employees, depend on for your paychecks.

I have to chuckle (bitterly) when I hear some corporate or government manager complaining of stress. If you have a steady paycheck, you have never experienced full-court stress. (With the exception of emergency medical care staff and U.S. Armed Forces personnel in combat duty, of course; I mean "regular civilian employment.")

Small business owners have to wear more hats than any corporate manager or government employee, and they do so without pay as times get tough. Many tap their own credit cards to pay employees and fill orders for good customers. You want stress? Then do whatever job you do for a paycheck but imagine that you're doing so with only the hope of future paychecks--a hope that dwindles every week that the economy continues its free-fall.

This is why I have predicted that local and state governments are completely ill-prepared for the tidal wave of small business failures which are about to decimate their tax revenues. The average municipal manager is assuming everything will return to normal soon, as all those faceless small-business worker bees will persevere and keep paying their rent, taxes and fees regardless of the hardships, stress and rising debts.

Nobody can operate their business for long when they're losing money. I would guess that over half of small businesses in the U.S. are already marginalized in terms of survivability, and very little separates those from their "if we can just get through 2009 we'll make it" brethren who still have a bit of cushion.

As noted here before, an entrepreneur always has an alternative "Plan B" livelihood : whatever one used to do in a formal, high-cost way, then do it informally from home. Do it for barter, do it for cash; pay no office or warehouse rent, have no employees, pay no business taxes, and whatever net income is left, it will be so low that the income taxes will be negligible.

If the politicos and government employees think they're in trouble now, wait until the end of 2009. When the streets are lined with closed storefronts, the chain stores and malls have been shuttered, and the auto dealerships are weed-filled empty lots, then go ask the survivors to pay more taxes and fees.

Oh, and here's where some state/local tax revenues are going (link courtesy of Cheryl A.): Double-Dipping Government Employees in Florida.

Sadly, there won't be many left to hear your pleading for more tax revenue. But go ahead and raise taxes and fees anyway, and drive the survivors under. Then the last businesses you can try to load up with higher costs will be Wal-Mart and Safeway and the local branch of Citicorp/WAMU/BofA/Countrywide/Morgan/Chase or whatever it will be called.

You can try raising property taxes, but as homeowner net worth and equity continues sliding, you may find some resistance to higher property taxes. You can start charging $10 to use the county park, and guess what, you'll find nobody needs to go there now. You can charge $10 a month to use the library, and guess what, you will either face a citizen insurrection or few will enter what was once considered a sacrosanct civil institution--the public library.

Or you can take stock and realise that government is an enterprise, too; it too needs to live within its means--especially as those means diminish along with the economy which supports you. Unlike the Federal government, you can't print money to pay yourselves or fund your pensions. You might want to focus on helping the goose which lays the eggs--small business--survive rather than devote all your energy to strangling it with higher taxes and fees.

You can either keep the libraries open, or you can fund your pensions. But you won't be able to do both.

The more taxes and fees are raised, the less tax revenue will be collected as the pool of small-business survivors melts under the strain. It's called a death-spiral, and we will all have ringside seats as 2009 unfolds its dark wings.

Lest you think this is just some outlier attitude, please read this commentary from an astute reader. This was written in response to my essayProductive and Unproductive Capital (December 27, 2008), but it resonates with the death-spiral I describe today:

"I compare today to say America in 1832 to 1942, what we did, what we believed, how we lived with mostly independent agrarian life, no distances, no transit, only walking to the homecoming game with your pal and your gal at the school 3 miles away. I keep saying, "does that sound so bad?" Is it so terrible to work where you live, in small, modest shop of our own making small, modest profits?

Your last post was insightful in this, which has a near-absolute effect on people who control and deploy capital. If there's all risk and no return, why deploy it? This single change could probably do more than any other. I am one of those capable of deploying capital, but all my life I haven't even once: the legal maze is incredible, the taxes are near 100% of profits, and the risk is total loss of everything you own, and with liability and garnishing wages, everything you might ever own. This same math drove my father out of small business altogether, and that was the early 90s when the gov't (including Fed debt) was 1/4 of todays' size. Was it too small then?

For example, here in Rochester, NY, there are 12-BR Craftsman mansions, all woodwork, fireplaces, show homes, 20min from the city, already cut into 3 apts for, oh $220,000. That's like giving it away. Replacement cost would be in the millions. You know what? The return on that investment is zero; the rents + taxes + risk would take ALL the profits, every penny: to the state, the bank, and the insurance companies.

That's why the present owner is trying just to sell it at breakeven. He doesn't want it either.

That's what I'm talking about in deploying capital, although laundromats, farms, restaurants, are all the same math. You work entirely for the State. Any profits are more than overshadowed by the additional risk. So I do nothing; and neither does anybody else. Do we get anything for this cost and nuisance? No. At least 30 miles north, in Canada, they GET something for their equivalent taxload: universal health care, and a system that has no personal risk. The dole is easy to get on, and there's no real stigma or bother attached to it. In NY we don't even get good roads.

It's nonsense. Go back to how it was--let the roads go back to dirt for all I care, cancel health care and everything else--despite the promises we don't really get it anyway. Most people out here would agree with me.

If we steal from workers and savers to give to speculators and borrowers, then why should people work for themselves anymore? And I can attest that here in NY, they don't. The farms were economically firebombed years before the rest of the economy. There's now no work people wish to do--although astonishingly there's still a lingering work ethic. So we do nothing, and nothing gets done.

Money won't solve this problem. That's the real point. Only work in the real world will. To get that, we need to reverse the reward structure 180' and reward people who work instead of those who shuffle, actively prevent the work of others, or who speculate.

History shows that will happen and despite recent appearances, it seems this may even happen peacefully, if with great hardship. Time will tell but the American people seem to be avoiding that path by not getting riled even when VERY put upon. They seem to be content with simply playing out all the rope that the present system needs. When it is completely nonfunctional, it will more or less hang itself without our needing to get off the couch. That's unconscious, and it's giving great benefit to the people, but here in the country, people KNOW they're getting screwed into poverty every day--and I mean actual no-heat, lose-the-house poverty. It's not as they say in the suburbs: that people are fat and lazy and don't know. THey seem to know well enough here but still prefer to play out the rope. I think people are more or less terrified of the explosion that might occur if they allowed themselves to get angry and take action. History would show, I believe, that their common sense in this is correct.

I liked the reader who spoke of "living on the land"--he has the relaxed and patient method I wish I had, although he wasn't able to flesh out this important idea so thickly. Living in farm country, thick with turkey and deer I can agree--hunting in a Depression is a dangerous fantasy. It took from 1932 to 1990 for turkey to return here, and only when re-introduced. Deer were virtually wiped out until the late 50s. There are no fish now even in normal times. Imagining hunting might work is an excellent way to get killed. Far better to buy a few hundred in garden seeds and a shovel, something I intend to write on if I can clarify a plan before people are already inside the storm. But you just can't write a 100-word essay on growing food. It's like being a doctor or a mason, it takes decades to learn to do well, everything is a soft-case exceptions, and only experience can teach you.

It seems like that idea that non-edible savings itself is illusionary, and that money is useless compared to real work are ideas that need to be explored. I look forward to seeing what you discover."

Thank you, reader. Here are two ideas to start with: tax the heck out of unproductive capital and unearned income, not just to raise revenue but to drive that capital into productive uses, and lighten the tax burdens placed on small business. The more that survive, the more tax revenues you'll actually gather.

10 New excellent reader comments.

New Essay by Eric Andrews:
Life and Cash-flow Accounting


Thank you, Mary S. ($25) for your most generous donation to this site. I am greatly honored by your support and readership.

Thank you, Dennis C. ($50) for your exceedingly generous donation to this site. I am greatly honored by your support and readership.