Monday, August 17, 2009

The Travails of Small Business Doom the U.S. Economy

Over time, the travails of small business will doom the U.S. economy.

One of the recurring themes here is the largely zero-coverage-by-the-MSM erosion of small business in the U.S. via hamhanded over-regulation and over-taxation. Correspondent Robert D. provided this first-hand account of why businesses either never get off the ground or fail shortly after opening.

You often mention the excessive burdens placed on small business by our friends in City Hall, the various State Capitals and D.C. I thought I might add my anecdote to the mess.

A few years ago my wife, 2 kids, 3 dogs, 1 cat, 2 gerbils and I moved to a picturesque small town on the Pacific Coast with a large historic district where my wife had a job offer at the local hospital.

I found work as a chef at the population center 1 hour+ commute each way by car, ferry and shoe. After a couple of years of 10-12 hour days plus the commute I was getting burned out. So when the new owner of a local boutique hotel asked for proposals for a restaurant to replace the failing "Gifte Shoppe" in his ground floor commercial space, I jumped on it. We shook hands on a sweetheart deal lease-wise as long as he did not have to contribute to any build-out costs.

That's when the fun began.

I sketched some plans and had them drawn up by an architect ($1000).

I submitted them for review to the County building Dept. ($300).

Everything was OK, except for the bathrooms. They were not ADA compliant. Newly built bathrooms must have a 5' radius turning space for a wheelchair. No problem. I tried every configuration I could think of to accomodate the larger bathroom space without losing seating which would mean losing revenue. No luck. I would have to eat into my storage space and replace it with a separate exterior walk-in cooler($5,000). I would also have to reduce the dining room space slightly so I had to plan on banquettes along the exterior wall to retain the same number of seats (banquettes vs. separate stand alone tables ($5,000) Revised plans ($150). Re-review ($100)

Next came the Utility Dept. It seems the water main was insufficient even for the current use, a 24 suite hotel, and would need to be replaced ($10,000).

Along comes the Historical Preservation Society, a purely advisory group of starched collar, pince nez wearing fuddy-duddies (well, not literally) to offer their "better take it or else" advice, or maybe lose the Historic Status tax break for the hotel.

It seems that the mushroom for the kitchen exhaust fan would be visible from the street, so could I please relocate it to the rear of the building? Pretty please? Extra ducting and more powerful fan ($5,000).

Hello Fire Dept! My plans showed a 40 seat dining room, 2 restrooms , a microscopic office, and a kitchen. My full staffing during tourist season was 4 servers, 1 dishwasher and 1 seasonal cook-total occupancy 47, myself included.

The Fire Inspector said the space could accomodate 59. "But I only have 40 seats. I want luxurious space around the tables." I pleaded. "No. It goes by square footage. 48 seats, 4 servers, 3 cooks,one dishwasher, 1 person in the office and 2 people in the restrooms." "Why would I need 4 cooks for 40 seats when I am capable of doing that alone? And if the cooks are cooking, the servers are serving, the officer is officing, the diners are dining, then who the H#$% is in the bathrooms?"

"Square footage. Code!" And therefore it went from Class B to Class A, requiring a sprinkler system for the dining room and a third exit ($10,000) in addition to the existing front door and the back kitchen door. It would have to be punched through the side wall and have a lit EXIT sign.

Could it be behind the screen shielding the patrons from viewing the inside of the bathrooms every time the door opened? Oh, no! It might not be visible. The door would have to be located where 4 guests at the banquette plus their opposite companions were seated-loss of 20% of seating unless I squeezed them into smaller tables destroying the whole planned luxurious ambience.

Pro Forma:

$250K sales.
$75K Food and Beverage purchases
$75K Labor cost
$75K Expenses
$25K net before taxes.
Result of above experience=Fugget Aboud It!!!

Loss to community-$100K income plus tips +$20K Sales tax.

Another "Gifte Shoppe" went into the space and closed a month after the end of tourist season. When we left town 2 years later to go sailing the Caribbean, the space was still vacant.

I might add that I had advice in all this from a retired executive who volunteered his time (small donation to Toys 4 Tots gratefully accepted) through a group that connected us. He said that in his opinion that my project budgeted at $200K would cost upward of $1 million in NYC and perhaps SF due to higher permits and fees.

Thank you, Robert, for this eye-opening report.

On the face of it, each of these mandated upgrades resolves a potential problem: access for the disabled, insufficient water supply, fire hazards, etc. etc. Each of these codes was put in place by well-meaning public servants and engineering professionals.

The only problem is there is no consideration of costs or marginal returns in the codes and regulations. If a business can't afford an ADA bathroom, then it can close--period, end of story. The visible benefits--enforcement of codes--trumps the invisible losses of what the business provided in employment, sales taxes, livelihood, etc.

There is no weighing of the high costs of meeting codes and the potentially marginal benefits generated--the business either meets codes are it shuts down.

I have sat in on earthquake safety and code revision meetings, so I know how the process works. A group of well-paid public servants and top engineers in the field gather around a table and brainstorm how they can reduce the risk of something bad happening to John Q. Citizen.

To contribute (and polish one's sense of accomplishment), naturally there are numerous possible improvements to existing codes and regulations. But since codes have been around for about 100 years, and have constantly been revised and tightened, there's not much left to "improve" except at the far margins.

So if two exit doors (egress) are good, then three is even better--and we can calculate the time needed to escape from a room. This is obviously a good idea because getting trapped in a conflagration is bad and every effort should be made to avoid that. As for cost, well, the third door is such a marginal cost compared to the value of the entire business--who can complain?

Right. Until you add up five or ten of these marginal projects.

I also understand the value of prescriptive codes--no judgment required, here are the calculations and here are the results.

OK, but when did common sense get pushed out the door in favor of essentially unintegrated codes and regs? Every municipality favors "green building" and so on, but try to install a used window or door--no way. It's not to code. So "re-use"--the greenest "technology" because it does not require enormous quantities of energy be expended manufacturing and transporting some new object--is out.

It's remarkably easy for employees of the city or county to "do their job" enforcing regs because the implicit assumption is that their own paychecks will continue coming regardless of how few businesses survive.

As public-sector employees are beginning to discover, that is not true. Since small business employs 80% of the nation's private-sector workforce and pays most of the business and payroll taxes, then strangling small business means tax revenues plummet and the city and county go broke.

Though most will deny it, I suspect there is a deeply seated anti-small business value system now at work in the U.S. While large corporations are wined and dined with huge tax credits--please come to our state, we'll pay you millions to move!--small business is left to shift for itself, receiving nothing but pandering PR about how "we value small business" served up with ever-higher taxes and regulatory burdens.

Beneath the phony hype about "valuing small business" lies a more corrosive assumption--that a business is a license to print money, and so whatever costs are dumped on small business, hey, they can afford it, they're rich.

Would you borrow $250,000 to start a business which might, if you're lucky, net 10%? That's your wage, pal, not the net-net--you have to pay taxes on that $25K, too--starting with 15% self-employment. But then the business might fail, and you lose the $250K and have to declare bankruptcy.

A business isn't a license to print money--it's a license for cities, counties and states to print tax revenues. The entrepreneur may or may not print money, but since 75% of all new businesses fail within a few years (and that's in good times; now the failure rate will probably run to 95%), the odds are they will lose all their invested capital and be broke, not wealthy.

So what could cities, counties, states and communities do to actually help small businesses succeed? The most important step would be to consolidate all the permits, reviews, etc. into one office which was empowered to grant exemptions on marginal return regulations and which lowered permit costs to a trivial sum (total permits to open a new business, under $100 for everything).

What are the costs to the community if not every restaurant has ADA bathrooms? Is a gutted downtown "worth" the costs of requiring every cafe have an ADA (American Disability Act) compliant bathroom? How about allowing the new cafe two exits instead of three? How much would that endanger the community? Would that endanger it more than an empty town center with no cafes at all?

These are value judgments which means they are ultimately political. When major corporations face some onerous regulatory burden, they often dodge it by going over the heads of locals and buying the good graces and kind services of state or national legislators. Small business doesn't have this kind of money and clout.

That means local officials will have to step up if they want to retain and nurture real businesses that hire real people and pay real taxes. Maybe realizing their own jobs depend on small business, too, will provide some motivation.

Codes and regs which make sense as individual ideas become straitjackets when layered on top of one another with no integration via a common-sense, cost-benefit, marginal-value analysis. The choice is clear: either nurture small business and enable its survival or cities, towns, counties and states will see their tax revenues drop in a death-spiral: the more they drop, the higher the taxes they place on surviving businesses, which then speeds their decline into insolvency, which further lowers tax revenue, and so on.

If you don't think this is already happening, go count the number of empty storefronts in your area--and then recount them in a year. The results will be telling.

The second most important "innovation" municipalities and states could do is only tax net profit. Toss out all the junk fees and permits and business license taxes on gross income; if there's no net, then why should the State collect more than the poor folks slogging their guts out trying to keep the doors open?

Here's another revelation: there are lots of simulacrum businesses on the books which generate no revenues, pay no taxes and which don't actually employ anyone. Counting them in the same column as real businesses is not just a disservice, it's misleading.

Amidst the decline of real businesses, facsimile businesses still abound in California. BusinessWeek crowed this week that there were 11% more new business filings in the state over the past two years (never mind 80% of them were probably filed before Lehman Brothers blew up in 2008). Later, in an unintended irony, they profiled a few new Silicon Valley startups which are supposed to lead the state and nation out of hard times. After all, this is where H-P, Apple, eBay, Google and PayPal all started.

One of the representative "bright lights" was a recent college grad in flip-flops pitching his software idea for selling art over Facebook, based on what users were "favoriting." Yes, art, the market for which has imploded, and Facebook, you know, that amazing national industry which employs all of 900 people (guesstimate).

I hate to be the one to state the obvious, but this is a facsimile "innovation," a facsimile business and it will not be an engine of employment or growth.Yes, there are real scientists working on biofuels and energy conservation and nanotech in the Valley, and any of these technologies might turn into a legitimate business. (If so, it will soon exit the state for lower-tax climes.)

But most of the Web3.0 ideas can be boiled down to this: come up with a "hot idea" and sell it to a desperate-for-"innovation" corporation. All these Web3.0 schemes ultimately reduce down to living off the same income stream: advertising. That is a modestly thriving business but you're not going to create another Apple or Google sharing that one rather modest revenue stream with thousands of other firms.

It's easy to set up a simulacrum "web" business; all you need is a cubicle or living room and an Internet connection. You won't have employees or pay taxes because you have no revenue. If you fail, no biggie--you didn't borrow $250,000 to launch, you used OPM (other people's money) or scraped by for a few months to see if you could get angel investors.

That's all well and good, but it's the height of blindness to confuse Facebook-based schemes with real businesses, and to strangle all the real businesses while you pin all your hopes on the next Google mushrooming out of nowhere.

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