Tag: Entrepreneurship

Tax Policy and Investment by Startups and Innovative Firms

Our tax system includes many provisions to boost business investment, particularly by startups and innovative firms. In a new Tax Policy Center study, Joe Rosenberg and I find that those incentives are often blunted by other features of the tax code:

We examine how tax policies alter investment incentives, with a particular focus on startup and innovative businesses. Consistent with prior work, we find that existing policies impose widely varying effective tax rates on investments in different industries and activities, favor debt over equity, and favor pass-through entities over corporations. Targeted tax incentives lower the cost of capital for small businesses, startups, and those that invest in intellectual property. Those advantages are weakened, and in some cases reversed, however, by two factors. First, businesses that invest heavily in new ideas rely more on higher-taxed equity than do firms that focus on tangible investment. Second, startups that initially make losses face limits on their ability to realize the full value of tax deductions and credits. These limits can more than offset the advantage provided by tax incentives. We also examine the effects of potential tax reforms that would reduce the corporate income tax rate and achieve more equal tax treatment across the various forms of business investment.

How Do Entrepreneurs Operate in Afghanistan?

“Uncertainty, not insecurity, is the fundamental problem for business” in Afghanistan according to a new study by Jake Cusack and Erik Malmstrom at the Center for a New American Security (ht: Zach W.). In “Afghanistan’s Willing Entrepreneurs: Supporting Private-Sector Growth in the Afghan Economy,” they report:

In national surveys, insecurity ranks at the top of the most serious concerns of Afghan businesses. However, discussions with local business owners revealed a critical qualification to this finding. Surprisingly, Afghans were more concerned with the uncertainty of the business environment than with physical insecurity. In Kandahar, which is considered one of the most dangerous areas of the country, conversations with business people highlighted uncertainty about the quality and timing of the power supply, about supplies flowing in through the border crossing of Spin Boldak, about the local/national government, about financing,about American force posture and about the sanctity of obligations should political power shift – more than security issues. In Kabul, two manufacturers noted that they had received seven-year tax break guarantees from a minister of finance only to see them rescinded by his successor. This act understandably rendered the companies reluctant to make subsequent investments.

So how do Afghanistan’s entrepreneurs respond to this uncertainty? Cusack and Malmstrom find that “businesses adapt by integrating vertically, emphasizing short-term profits and ‘buying’ security”:

Businesses employ a number of common strategies to adapt to Afghanistan’s uncertain business environment. First, they seek to vertically integrate operations, generally within family and tribe, to minimize reliance on untrustworthy business partners and the government. “We have the most corrupt government and people in the world. I don’t like relying on people outside of my family if I don’t have to,” stated Mohammad Jalil Rahimi, General Manager of the Mazar-based Barakat Group, an import-export conglomerate. The process of vertical integration begins around a central business, often import-export, and grows to include supporting businesses, such as transportation and logistics. It can then grow to include other sectors such as construction, agriculture and light manufacturing.

Second, businesses seek to remain as flexible as possible in order to hedge against uncertainty, valuing short-term but dependable gains over developing long-term productive capacities. A Western official explained, “Afghans go to the highest-margin businesses that require the least amount of capital and that produce benefits in the least amount of time.

This means that they often start in trade, then pick productive business opportunities in services, agriculture and construction. But even then, people are loathe to invest in manufacturing versus trade because it is easier and quicker.” Despite this adaptation, producers continue to face challenges from a variety of sources. For instance, a Mazar cable and wire producer was being put out of business due to competition from cheaper Iranian imports; a Jalalabad-based box manufacturer could not afford his onerous credit payments, was accumulating debt and was unable to sell his business; and a Kandahar beverage company could not convince needed Pakistani technical engineers to visit and repair manufacturing breakdowns.

We observed four primary strategies for managing physical insecurity: 1. shifting operations away from unstable areas; 2. negotiating with government or insurgent power brokers, often through payment of informal taxes and bribes; 3. allocating up to 20 percent of an operating budget to formal security costs, including a security director, guards, etc.; or 4. implementing community-based strategies in cooperation with local elders and staff. The choice businesses make depends on an individual business’ toleration of risk, past experience and influence within society. An Afghan mining executive explained his predicament: “I can’t complain to the police or the government because it will make the problem bigger. My only strategy is to negotiate directly with the Taliban. My last option is to pay them. But I don’t want to pay them because it will make them stronger.”

Well worth a read.

For previous discussions of Afghanistan’s economy, see this post on resource wealth and this one on opium.