The War on Small Business

by Addison Wiggin & Ian Mathias

• The War on Small Business: Washington’s long train of abuses against entrepreneurs

• Health insurance costs, paperwork requirements, stepped-up audits… It’s worse than ever

• The “assault on enterprise” coming to film… A sneak preview of our new documentary project

• “Bears on their heels”… Taking stock of stocks as the summer doldrums come to a close

• Readers sound off on “sarcastic political commentary” and rare earths

  Today, we revisit a recurring theme: the assault on enterprise. It was the subject of our symposium in Vancouver in July. In this episode, we look at a particularly vulnerable segment of the economy: small businesses.

  To help set the stage, let's look at some important stats from the Small Business Administration (SBA). Small businesses:

• Represent 99.7% of all employer[s]

• Employ just over half of all private-sector employees

• Pay 44% of total U.S. private payroll

• Have generated 64% of net new jobs over the past 15 years

• Create more than half of the nonfarm private gross domestic product (GDP)

• Hire 40% of high-tech workers (such as scientists, engineers and computer programmers)

• Are 52% home-based and 2% franchises

• Made up 97.3% of all identified exporters and produced 30.2% of the known export value in FY 2007.

• Small firms produce 13 times more patents per employee than large patenting firms; these patents are twice as likely as large-firm patents to be among the 1% most cited.

  Further, if you look to the Kauffman Foundation, startup firms are the "sole engine" of job creation in the U.S. economy.

Kauffman crunched a data set from the Census Bureau covering the years 1977-2005. In all but seven years during that period, existing businesses cut an average 1 million jobs… while firms in existence for a year or less created 3 million.

“Policymakers tend to focus on changes in the national or state unemployment rate, or on layoffs by existing companies,” explains Kauffman VP of Research and Policy Robert Litan. “But the data from this report suggest that growth would be best boosted by supporting startup firms.”

Instead, these small firms are being strangled. Let us count the ways…

  According to the National Business Group on Health, the typical large business will see its health insurance costs rise 9% next year.

But for small businesses, the numbers are rising faster. Small employers in California are looking at increases of 12-23%, on average, according to the Los Angeles Times — one got notice of a 76% increase.

It’s an acceleration of a long-standing trend…

The government has skewed health insurance costs in favor of larger businesses for decades… and now the “health reform” law signed this year is tilting the scales that much further.

  Then there’s this nugget tucked into that other legislative monstrosity known as “financial reform”: Starting in 2012, every business must issue a Form 1099 to every vendor from whom it buys more than $600 in goods or services every year.

So if you’re a small businessperson and you order $601 in office supplies from Staples over the course of a year (better keep a running total), you must issue a 1099 to Staples.

26 million sole proprietorships alone will be caught up in this net. SMC Business Councils, a business networking group, reckons its typical member currently files about 10 1099s a year. Under the new rules, SMC estimates the number could reach 200.

The idea behind this requirement is to increase compliance with existing tax law. The unintended consequence is it will bury small businesses in paperwork.

Very small firms with fewer than 20 employees already spend 45% more per employee than larger firms to comply with federal regulations, according to the SBA.

  And yet… right on cue… a study released by the pithily named Transactional Records Access Clearinghouse at Syracuse University shows the IRS has increased its audit hours of small businesses (those with less than $10 million in assets) by 30% over the last five years.

At the same time, large corporations’ audit hours are down 33%.

The average amount of “underreporting” found for each audit hour of a small- or midsized business was $1,025. For a large corporation, it was $9,354.

Hmmmn… that's a good trend if you’re a lawyer at a Fortune 500 firm. It's bad if you're trying to book a tee time or grow a small business.

  Individual sectors are also getting hit hard…

• The financial reform law is hitting small community banks with big regulatory hurdles. “We will no longer be able to evaluate loan applications based solely on the creditworthiness of the borrower,” complains Sarah Wallace, chairwoman of a small thrift in Ohio, in The Wall Street Journal. “We will be making regulation compliance decisions, instead of credit decisions”

• The requirements buried in a “food safety” bill likely to pass Congress this month will have a devastating impact on small farmers. “This could make farmers markets go away,” farmer Scott Frost tells the Portland Oregonian. “The only guys left standing in the room will be the big gorillas." That’s because the big boys can easily absorb the record-keeping requirements (and annual fees) that come with the bill.

  It's not just the Feds looking for a piece of these guys. Small businesses are looking juicy to revenue-starved state governments. To wit…

• Pennsylvania is looking to add a 6% sales tax to plumbing and electrical services

• Wristwatch repair may become subject to a 4% sales tax in New York

• Four states are looking to join the 26 that already tack on a tax or fee at bowling alleys

• Want to go horseback riding in Arizona? The stable owner may soon have to charge you a 5.6% sales tax

• Three states may opt to start taxing interior decorating services.

  Given the environment, this next nugget should come as no surprise.

The National Federation of Independent Business puts out a monthly “Optimism Index” of small-business owners it surveys. Last month, that number sat at 88.1. The last time the number stayed above 90 for longer than three months was early 2008. It was over 100 as recently as October 2006.

“The persistence of Index readings below 90 is unprecedented in survey history,” says the NFIB. Contrast its readings over the last five years with, for instance, the big-business ISM manufacturing index, which has pointed to expansion for over a year now…

“It seems,” Barron’s columnist Randall Forsyth writes archly, “America's entrepreneurs were too busy struggling with their own businesses to read all the accounts in the media about how terrifically the economy is doing.”

  When NFIB survey participants were asked what is the single-most-important problem facing their business, a plurality of 29% said “poor sales.” But right behind that…

• 22% cited taxes

• 15% cited “government regulations and red tape”

• 7% cited “cost and availability of insurance” — as we’ve seen, a government-created problem.

Only 4% cited availability of credit. Good thing we spent billions in bank bailouts to keep the lines of credit open, isn't it?

  "Far from being the exception, crises are the norm," writes Nouriel Roubini in the introduction to his new book Crisis Economics. "Crises — unsustainable booms followed by calamitous busts — have always been with us, and with us they will always remain…

"The very things that give capitalism its vitality — its power of innovation and its tolerance for risk — can also set the stage for asset and credit bubbles and eventually catastrophic meltdowns whose ill affects reverberate long afterward."

Unfortunately, the reforms set in place now — as is so often the case — come replete with unintended consequences. Those consequences are threatening the very goose they're intended to save.

[Ed note. As you may know, we’re making a film about entrepreneurs in the wake of the crisis. One of the case studies we’re drawing on is that of the frequently harassed entrepreneur Greg Stemm, founder of Odyssey Marine.

For decades, he and his teams have plumbed the bottoms of the ocean to find and recover treasure left in situ after ships have plunged to their deaths. For their toil, they’ve often been rewarded with the threat of litigation from governments seeking to skim some (or all) of the proceeds for themselves. Greg is also the source of great consternation in the academic world because of his efforts to introduce a "commercial model' to the world of undersea archeology. Heaven forbid the gentleman make a profit!

As you'll see, our film is still very much a work in progress, months away from release… but we’ve captured a small part of the Odyssey Marine story in a seven-minute clip we caught of Stemm and Neil Dobson, one of his archeologists, as they're ogling some coins they'd only recently returned to the New Orleans Mint for a museum exhibit. As faithful 5 readers, you get first crack. Check it out here.

You'll also note there is an offer for some of the coins Odyssey brought up from the wreck of the SS Republic. That offer comes by way of our ongoing business relationship with First Federal Coin. It's our modest effort to introduce a "commercial model" into the all-too-stuffy world of documentary making. But you should be aware that if, in fact, you choose to take advantage of the offer presented, we're likely to receive compensation.

Otherwise, we’ll keep you posted as the film gets closer to a final cut. Enjoy…]

  “Bears are back on their heels,” says Options Hotline editor Steve Sarnoff of this week’s stock market action. The major indexes opened flat this morning on news that first-time jobless claims fell slightly last week. That had the effect of merely canceling out what turned out to be an increase last week (darn those revisions).

Steve offered this pithy summary of the week so far in an alert to readers last night…

• Monday: No follow-through from bulls… stocks lower from resistance on weak economic data

• Tuesday: Another roller coaster day on Wall Street… indecision in the market may signal a turn

• Wednesday: A very strong bounce-back day for stocks as they surge up from key support.

Steve’s been playing the volatility for all it’s worth: As of Tuesday, his recommended puts on Intel are up 159% in six weeks, while his recommended calls on Barrick Gold are up 164% in just three weeks.

His next recommendation comes in 10 days. If you’d like to be on board, here’s where to go.

“The range-bound S&P chart between 1,130-1,040 for most of the last year can set up an optimist for a rally back to the April highs,” says our resource man Alan Knuckman. “That is IF 1,040 holds again on a monthly basis and the next earnings cycle proves corporations can continue to exceed profit expectations. Money is being made to fill company coffers even without an all-around recovery.”

”The shorts have been squeezed many times over the last two years, so it will be interesting to see what happens from these levels again. A little forced buying to close out the summer sales can provide some much-needed support. The stock indexes were down only 1% last week as the low-volume season comes to an end and business gets back to normal, albeit a new, undefined normal.”

  The dollar index is pretty much unchanged at 82.4 this morning. Spot gold is back within $10 of its all-time record at $1,250.

“I just started getting your newsletter last week and was dismayed to see you engaged in sarcastic political commentary in [yesterday’s] letter. That's not what I subscribed for. Why don't you stick to investment-related topics?”

The 5: Since you’re among over 10,000 new readers who’ve joined us in recent weeks, we don’t mind repeating ourselves here: We’d be content to ignore politics were it not for the fact that politicians keep finding new ways to meddle with the economy and our investments. We furnished copious examples just today.

Other times the connection is less obvious, so if you’re complaining about our jaundiced observation that the Iraq war has strengthened Iran’s hand in the Middle East, we simply invite you to ponder how an emboldened Iran might drive oil to $220 a barrel in 18 months. You’ll find the supporting evidence here.

  “Love your work 5 Min. team — great stuff," writes another from down under. "Read it over here in Aussie every morning. One rager you haven't talked about is rare earths. Most of the 17 underlying elements have at least doubled this year in price (some up four times). China has increased its export restrictions to 70% (it currently supplies 97% of the world's rare earths), which has lit a fire under the rare earth prices.

“I would have expected a little more than zero media coverage from the Americans considering you need certain rare earths for military requirements plus a whole lot of other key new technologies that everyone seems to deem so important (iPhones, TVs, DVDs).

“The big kicker for rare earths remains green technology, which despite its move to the middle pages of the paper is most likely going to 'rare' its head once you guys stop printing money, take your medicine like a good boy and face the 'depression' front on, rather than letting it ‘rare end’ you.”

The 5: Actually, our resident geologist Byron King’s been thumping the tub for rare earths since early 2008. In fact, he’s speaking at a conference on rare earths in Washington next month. So we’ll have plenty to say in the weeks ahead.

  “I find it instructive,” a Reserve reader writes, “that the Obama administration wasn't much interested in Social Security reform until the program started taking money out of the general fund, by selling government paper, rather than buying it. Supposedly, the 'recovery' we are experiencing will change that, but don't hold your breath.

“Frankly, I hope they don't do anything. I'd much rather see government money going to retirees and the occasional genuinely disabled worker than be used to kill Arabs or to lock up people who have grown pot in their basements.

"Besides, the sooner the U.S. dollar goes belly up, the sooner we will be back on the gold standard. It has happened in this country before, after the failure of the Continental Dollar and the elimination of the Lincoln Greenback.

“Yeah, yeah, it will never happen. History never repeats itself, and it is sure to be different this time. In the meantime, keep your bullion hidden, or vault it in Zurich.”

The 5: And readers accuse us of fostering sarcastic political commentary. Sheesh.

Indeed, we can help you store your bullion in Zurich… under the runway at Zurich Airport, to be more precise. Our friend Egon von Greyerz with goldswitzerland.com has access to just such a vault. (If you contact Egon, please let him know Addison sent you.)

We also continue to get good feedback on this unique approach to the creaking Social Security system, the one we call the “other” government-backed retirement program.

Regards,

Addison Wiggin

The 5 Min. Forecast

P.S. How solvent is your bank? Imagine if you could access a document that predicts when a certain bank stock is going to fall. Even better, imagine if you had an expert who could access hundreds of such documents and cull the best shorting opportunities on your behalf. Imagine what you could do with such knowledge. Imagine… here.