4 Economic Reforms to Ignite American Startups

One of my favorite things about Uber — aside from the unbeatable convenience and price — is the drivers are typically very interesting to talk to. Everyone has their own unique story.

During one particular Uber ride of mine, I found out the driver was originally from Eritrea, had only been living in America for the past 18-months, and lived in Italy for two years prior to moving here. From the beginning of the conversation, he could not stop talking about how great America was. It wasn’t an “oh I love this place” facade simply for the sake of getting a 5-star rating from this particularly patriotic rider– it was a genuine love for America, which was clear simply from the smile on his face as he was describing how it felt to live here.

He mentioned that in Italy, 50% of immigrants were currently unemployed (it’s closer to 15% after fact-checking that one)– and he was clearly bitter about it. He said even though Italian life was slower and easier, he without-a-doubt preferred the American lifestyle, which he described as much more fulfilling.

That conversation got me thinking– these jobs driving for Uber that this hard-working man and countless others are relying on were almost never created due to the lobbying efforts of the taxicab industry. These expensive legal battles took place in our local DC city politics in 2012, mid-2013, and late-2013, as well as other major cities such New York City.

As a nation, we say we understand the personal and economic value that startups bring to the country, yet we allow large status-quo corporations to lobby our politicians in an attempt to block innovation and prevent competition. When it becomes a game of “who can lobby Washington the best” instead of “who can outcompete each other”, the well-funded legacy corporations have the clear advantage over bootstrapped startups. And everyone loses.

America is still a great place to launch a business, but here are four policy reforms we could enact today to make a difference tomorrow. And I quite literally mean tomorrow. These reforms, if put in place today, would make a material difference tomorrow. Ahh, the powers of a free market, such a beautiful thing.

Without any further adieu, four policy reforms to boost entrepreneurship in America–

1. End the crony capitalism slowing down startups

What do Tesla, Uber and AirBnb have in common? They all had to fight expensive legal battles with large companies that lobbied politicians to shut them down.

Tesla, Uber, AirBnb, as well as plenty of other promising startups are attempting to disrupt stagnant old industries as we speak. But due to our culture of lobbying, it’s becoming easier for the large companies to lobby politicians to build regulatory moats around their business interests rather than out-compete the newcomers the traditional way. Not only is this strategy of “out-lobby over out-compete” un-American, it hurts our long-term economic outlook because it stifles innovation.

Is this politicians’ fault for caving to lobbyists? Or this is a policy failure that allows lobbying to be so much more effective than competing? Probably a little of both.

Politicians need the money
The simple answer is that, like almost everything else, it has to do with money. It costs a lot of money to run a political campaign, and although more money doesn’t guarantee positive results, it probably helps considering 86% of top-spenders in the 2010 House race won their election. [NOTE: It’s important to mention that correlation does not mean causation– winning candidates might’ve raised more money simply because more people liked them and therefore donated to them]. Regardless, corporations are astutely aware of the role money has in an election, so naturally they lobby and contribute accordingly in order to protect their interests. If a politician does something that their financiers don’t like, guess what– no more financial support will be coming their way in the next election. No industry is safe from this cronyism, not even the beer industry.

Suggested reforms to fix crony capitalism
Contrary to what political pundits want you to believe, economic issues are very complex and the answers seldom simple. Same goes for fixing crony capitalism. There is very little dialog regarding crony capitalism, so the suggested reforms currently on the table are few and far between. However, Steve Case tweeted it best–

Steve Case hit the nail on the head with the general premise– money spent on improving and modernizing a business must be a better investment for the company than spending it on lobbyists or campaign contributions. As far as specific reforms, Brookings Institute suggested that the problems stemmed from underfunded and understaffed congressional offices that rely too much on outside influences for research, as well as lack of transparency and accountability.

More funding for congressional staffs as well as enacting reforms to improve transparency and accountability in terms of outside influences, lobbying efforts and campaign contributions does seem like the best bet to address the issue of crony capitalism. However, things like trying to overturn Citizen’s United or restricting campaign contributions is absolutely not the answer, because lobbying is not inherently bad.

2. Encourage more competition between Internet Service Providers

As Americans, we sometimes live life in our own little bubble, completely oblivious of how things work outside of our borders. That’s especially true regarding how bad our internet is. We pay more and get less than the rest of the world. This hurts two groups in particular– it hurts consumers who aren’t getting a good value for their money, and it hurts innovative businesses who rely on fast, high-quality internet connectivity.

Like many policy debates, improving our internet is a complex issue, but the net neutrality debate is discussing the symptom rather than the disease. Robert McMillan is absolutely correct when he says the focus of this debate should be the lack of competition between internet service providers, and how we can increase competition among them. The fact that Comcast is able to charge YouTube and Netflix more and restrict their bandwidth isn’t the unsettling part– the truly unsettling part is that Comcast has enough power over these companies to do so and not be concerned about losing them as customers. In a true market where Comcast has to compete against other ISPs, if they act immoral or have unfair pricing policies, they will lose customers fast and go out of business. But in today’s market, they are essentially a monopoly.

It’s tough to say what the best pricing structure is for the broadband industry going forward, but it’s dangerous to allow one company to determine that structure without competitors keeping them honest.

With more competition between ISPs, consumers could expect quality to go up and prices to fall. This would put more money in consumers’ pockets to be spent elsewhere– a net positive for the entire economy, especially startups and small businesses relying on consumer spending.

More competition would also mean startups and established companies that rely on and negotiate with ISPs — such as YouTube and Netflix — will be able to negotiate on a level playing-field, which is also a net positive for small business and startups as well as the overall economy.

How can we increase competition among ISPs? it would probably start with your local government, who has the final say on which ISPs are allowed to enter their market.

3. Shrink the wealth gap and reignite consumer demand

Income inequality should be a bipartisan issue, especially for people who consider themself pro-market and believe in capitalism.

More customers is good, less customers is bad
From a startup’s perspective, more potential customers to sell to is always a good thing. But as the income inequality gap widens, lower-income households experience a decrease in disposable income and are unable to spend as much money as they would like. This decreases the size and scope of the market for almost every startup and small business.

Being put at an extreme disadvantage reduces performance
In book Top Dog: The Science of Winning and Losing, Po Bronson and Ashley Merryman discuss two interesting studies regarding competitiveness and performance–

One study of Air Force Academy cadets found that when squadrons were comprised of a significant majority of academically high-performing cadets and only a few academically low-performing cadets with no cadets in the middle, the low-performing cadets dropped out at a much higher rate than low-performing cadets of a squadron with more evenly distributed skills. Also, the academically-average cadets placed in squadrons with only other academically-average cadets outperformed the average cadets in evenly distributed squadrons. The results were repeated over and over again. This suggests when people have decent odds in a competition, they perform at a high level, and when they believe they have no chance at all, they fail.

Studies of corporate sales contests also come to the same conclusion– performance is boosted between 10% and 50% when the sales contest is a fair matchup between salespeople and everyone believes they have a fighting chance to win.

Capitalism is one big competition. By closing the wealth gap, we can essentially give more people a psychological boost by making them feel like they have a fighting chance to get ahead. This will empower them to do amazing things such start businesses and be more valuable employees.

A simple, nonpartisan way to address the wealth gap
The wealth gap is an immensely complex issue, and saying there are a few simple fixes would do the entire debate a disservice. With that being said, raising income taxes on the wealthy will do nothing to fix the problem. Unlike most Americans, individuals in the top 1% earn most of their income from businesses and investments, not from a salary, which are taxed at different rates. Therefore, raising the marginal income tax on the wealthy would do very little for two reasons– first, majority of their income is not salary-based and therefore not subject to income tax, and second, most have the flexibility to adjust how they earn their money to lower their tax burden anyway.

A simple fix is to reform our tax code’s treatment of different forms of income. From a free-market standpoint, the government giving preferential treatment to one form of income over another seems wrong. In this specific case it’s government favoring income from capital gains and dividends over income from a salary. Despite how “pro-business” that may sound, it’s still distortionary. Taxing different forms of income at different rates is also a driving force behind why many tax loopholes exist in the first place– people do whatever it takes to reclassify their income towards classes that are taxed the least.

Ideally, the tax code would look very similar to what the Simpson-Bowles plan suggested– three broad tax brackets with lower rates that don’t distinguish between types of income, and absolutely no deductions or credits.

Some might argue that taxing capital gains and dividends at the regular rate instead of a special lower rate would hurt business investment, but I would counter that a) the new lower rates would mean the overall increase in the tax rate on capital gains would be small, b) a less distortionary tax code would mean companies can make decisions based on what’s best for them instead of what will lower their tax bill, and c) less complexity in the tax code means people and corporations alike will spend less on compliance costs, which are unproductive uses of capital.

4. Urge the S.E.C. to adopt rules for JOBS Act Title III to allow the crowdfunding industry to flourish

Discrimination is alive and well in America. In fact, it’s written in our laws. The SEC restricts certain people from investing in startups solely based on how much money they make and what their net worth is.

On principle alone, barring a significant majority of the population from investing in one of the most lucrative asset classes is obviously unjust. But with the rise of equity crowdfunding platforms, fixing this law becomes even more important for two reasons–

First, the crowdfunding industry can’t grow, evolve and mature until these rules are adopted. There’s just too much regulatory uncertainty for anyone to build anything substantial. Given the ease and simplicity of raising money through equity crowdfunding, a robust and healthy crowdfunding industry would do wonders for the entrepreneurial landscape of America.

Second, as the crowdfunding industry develops, more and more companies will utilize it to raise money, and some investors will get very wealthy from these investments. However, until these rules are adopted by the SEC, only the wealthy will have the opportunity to invest. If we want to make an honest attempt at improving the wealth gap in this country, we must allow everyone the opportunity to invest in the next generation of great companies when the potential return is the greatest– while they are still early-stage, privately-held businesses.

The JOBS Act and Title III
In April 2012, President Obama signed the JOBS Act into law to ease some restrictions on startup investments that have been in place since the 1930s. Many benefits of the bill were enacted immediately, but the SEC has dragged their feet in defining and adopting some of the most important reforms, mainly Title II and Title III. [UPDATE: since this article was written, the SEC did move forward with adopting rules for Title III, however the recommendations below didn’t make it into the law, so there’s still room for improvement]

Title II lifts the ban on “general solicitations”, allowing small businesses to publicly announce they are looking for investors, as long as the business only accepts investments from accredited investors. Title II was finally adopted in the summer of 2013, about 15 months after the JOBS Act was signed into law.

Title III, which allows small businesses to accept investments from the general public on crowdfunding platforms, is still pending adoption by the SEC. On October 23, 2013, the SEC proposed rules for Title III and offered a 90-day public comment period before the rules became law, which should’ve happened on January 21, 2014, but that deadline came and went.

Although their proposed rules will make it dramatically easier for the crowdfunding industry to develop, there is still room for improvement, specifically-

  • Increasing the $1M cap on how much a startup can raise– even some kickstarter campaigns have surpassed this limit, as have syndicates on AngelList
  • Lift all caps on how much an individual can invest– if someone wants to invest, let them invest. Having a individual limit on investment means funding rounds will have more investors than necessary, which can complicate future fundraising rounds for the startup.
  • Eliminate the set lock-up period to give the investments more liquidity and the investors more protection
  • Ensure the simplicity of SEC reporting requirements
  • The restriction on crowdfunding platform from “offering investment advice or recommendations” concerns me. If a platform wanted to develop their own ranking system or algorithm regarding how lucrative or risky a particular investment might be, they should be allowed to. This rule might hinder innovation within the crowdfunding industry.

Closing Thoughts

So there you have it– four reforms that if enacted today would provide a substantial boost to the startup community in America. Have any thoughts? Do you have any more ideas? Leave comments below!

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Stephen Steinberg

Stephen Steinberg

Stephen is the Founder of Vapor Fresh, a line of safer plant based cleaning products for the sports & fitness industry, as well as Founder of Animate Yerba Mate, a brand bringing quality unsmoked organic Yerba Mate teas to the USA.