THE AMERICAN MIRACLE
“TAX SHELTERS ARE A GOLD MINE OF RISK-CAPITAL”
ABSTRACT
Passage of the 1981 Economic Recovery Tax Act reduced all taxes, but reduction of one (the
capital gains tax), unexpectedly turned out to be many times more important than all others
combined. When that tax was reduced from 35% to 20%, trillions of dollars in capital locked
up in Tax Shelters were transformed to a virtual goldmine of “risk-advantaged” investment
capital. “Overnight” this tax shelter risk capital instantly became available to millions of latent entrepreneurs in every corner of a vast economy. This resulted in (a unique “distribution
factor” whose breadth of reach is not available to any other source of capital, none)
Availablity of risk-capital jump-started new “micro” businesses “overnight”
from about 250,000 a year to a million a year. Since 1981, some 30 million
largely invisible micro businesses have generated about 90 million (net)
new jobs and about 80% of all household American wealth ($80 trillion by
2014 up from $10 trillion in1980) Europeans have called it the “American
Miracle.” (1)
Of the 30 million U.S. incorporated businesses 98% are small businesses and
80% are “micro” businesses with less than 20 employees. They are the primary job and household wealth-creating engine of the U.S. economy. They are
not publicly traded, so are largely invisible and operate almost totally independently of the (2%) of remaining big businesses.
By contrast since 1981, those 2% of big businesses with more than 500 employees have lost a (net) 30 million jobs (a million a year on average). They are publicly-traded and are disproportionately highly visible. Most remarkably, 90% of
the famous corporate name listed in the 1980 Fortune 500, have since disappeared through downsizing and restructuring. (2)
This historic explosion of new businesses has been stalled out since 2008 by an increase in the
capital gains tax from a most recent 15% to 28% and by enactment of an average $1.8 trillion
each year (since 2008) of regulatory ““glue” (3) This “glue needs to be rescinded for new startups and the tax now needs to be eliminated to restart the economy.
No tax net revenues would be lost by total elimination of this tax, because the
multiple new tax-paying, wealth-generating jobs created would again far exceed
any miniscule taxes levied on new start-ups. Net taxes would again surge.
The conversion of” tax shelter savings” to “risk-capital” is of historic importance. It fills a critical
gap called the “Valley of Death”) where the risk-capital needed for development and scale-up of
new discoveries is missing. New discoveries result from U.S expenditures of some $550 billion
each year for R&D and $80 billion for basic research. (4) Both expenditures are more than all the
rest of the world now spends combined. As a result, the U.S. makes almost all the next-generation disruptive discoveries. But basic research discoveries are far from commercial realization.
They must first move sequentially through stages of “proof of technical feasibility” and then of
“commercial feasibility” (the “valley of death,”) before scale-up.
-2BACKGROUND
Entrepreneurs have been the change agents of history who only over the last 5,000 years have
“finally” been allowed to incrementally build an advanced civilization on one single small rock in
a vast galactic universe. Entrepreneurial creativity has existed on earth for 200,000 years, generated by a genetic split between the Neanderthals and Homo sapiens. (5) But this creativity has
only been effectively released during an intermittent slow, tedious and uncertain 500 year pattern of the rise and fall of the great nations of history. (6) (Figure I)
FIGURE I
RISE OF THE GREAY NATIONS OF HISTORY
CIVILIZATION
PEAKING PERIOD
Babylonian Empire
Greek Civilization
Roman Empire
(Lost Ages)
Medieval Period
Rennaisance Period
Now
1,000 BCE
500 BCE
0
5 CE
1,000 CE
1,500 CE
2.000 CE
The critical conditions which finally released U.S. entrepreneurial creativity resulted quite inadvertently from passage of the 1981 Economic Recovery Tax Act. Similar conditions now can
be introduced into many other developed and emerging countries, with profound consequences for increased global quality of life.
Several general conditions are first required
(a) The first requires establishment of political stability with a rule of law and personal property rights. However, only about 20% of world populations in the free world
have established these conditions. Also unfortunately some 80% of the 7 billion
people in world populations still live in underdeveloped countries, where these conditions cannot yet exist.
(b) The second requirement involves an urgent need to remove bureaucratic and regulatory barriers to the incorporation and operation of new “small” businesses. All developed nations are litigiously buried in this regulatory “glue.”
(c) The third is uniquely important. It requires provision of powerful incentives for indivdual entrepreneurs (who exist everywhere) to invest “their own risk capital” (not tax
dollars) in new growth opportunities. The unexpected solution to this need inadvertently resulted from enactment of the 1981 Economic Recovery Tax Act, which quite
unintentionally released a torrent of risk advantaged capital from “tax shelters.” The
result was the explosion of new entrepreneurial businesses and creation of the
“American Miracle”).
-3Reduction of the U.S capital gains tax provided the unique distribution mechanism which alone,
searched-out latent entrepreneurs in every dark corner of a vast economy (This “distribution
factor” is not available to any other funding source).
The process also by-passes inefficient, risk-averse and bureaucratically-encumbered banks and inefficient Government Agency tax dollars, as funding sources.
Quite separately, the process generates a third essentially independent “growth”
economy. About 5% (25,000 a year) of the new “micro” businesses formed, capture
next generation disruptive U.S. discovered basic research innovations, to grow
to be big businesses and replace the famous corporate names lost each year.
Venture Capital organizations statistically have produced 2 or 3 out of 10 commercial successes
with 2 or 3 failures and the rest “walking wounded.” (7) The 1999-2000 dot-com bubble contributed to the 2000-3 deep recession, and about 80% perhaps of those investments probably
should never have been funded. By contrast, the success rate has been much greater for
investments made by individual (tax-incentivized) entrepreneurs, who are investing their own
money (not tax dollars) with a strong incentive to achieve commercial success. Government
Agency tax-subsidized investments also often have been notoriously poorly spent.
SUMMARY
Billions of computers, some 7 billion cell phones, an Internet and multiple satellites now tied
the world together in real time. Instant-connectivity also allows overnight mass-assembly of
thousands of protesters in any city square, a capability that has triggered the Arab Spring
Syndrome. This Syndrome may be expected to progressively spread into many other authoritative regimes. However, chaos is not conducive to economic development and strong U.S.
leadership will be required to save civilization from the barbarians (now perhaps for the 3rd
time at the 11th hour).
However, instantaneous connectivity also allows capital and information to flow with the speed
of light all corners of the planet, bringing to realization an historic “dream” of personalized
education and a world literate society. Reverse engineering of Western technology has been a
short cut for emerging country economic development and for increasing self-sufficient economic growth.
It could be the best of all times.
Emergence now of an educated world population is perhaps conceivable for the first time ever
and the procedures needed for accelerated economic development of emerging nations are also
clearly understood. The U.S. has an overriding responsibility in its enlightened self-interest, not
only to reactivate economic growth in the U.S, but also to lead the process required to reestablish world political stability and to help catalyze adoption of the required conditions required for
accelerated economic growth in many other countries.
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-4REFERENCES
(1) The American Miracle; P. Gompersm, J. Lernrer, “Enytrpreneurial Spawning, J of
Finance, Vol. I No. 2, April (2005)’ Kauffman Foundation, “Job Data in the U.S.
completely Driven by New Strart-ups.” Rosana@weitekamo.com
(2) Demise of Fortune 500 Companies. Fortune 500 historic data bases
(3) Regulatory “glue;”www.assheadnatiom.com “Regulations cost $1.8 Trillion Annually
(4) U.S .Research expenditures; National Science Foundation, Science and engineering
Indicators (2009).
(5) Genetic Split; Wikipedia, “Neanderthal-Homo sapiens Genetic Split”
(6) Rise and Fall of Nations. “The Maunder Minimum and Climate Change” John
Bockman, Library and Information Services in Astronomy III, ASP Conference Series,
Vol.153, (1993); “The Sunspot Cycles” Solar Science. Msfc.gov/sunspot cycles. D
Bruce Merrifield, “ “Global Warming, Rise of Civilization” Web Page Pridco.net
“Entrepreneurship”
(7) Venture capital Statistics; Small Business Administration Statistics; “Small Business
Share of U.S GDP”; U.S. Treasury Department small business data (2009)
Hon. D. Bruce Merrifield, PhD
Former V.P. Technology, Occidental Petroleum Co.
Former Undersecretary. U.S. Department of Commerce,
Technology and Economic Affairs, Reagan Administration; Chaired Professor of Management, Entrepreneurship, Wharton School of Business, University of Pennsylvania.