The Small Business Revolution is coming to America.
President Trump's proposal to cut the small business tax to 15% could be the most consequential legislation in a generation. Tax relief for small business will finally allow American entrepreneurs to compete against Corporate America on a level playing field. It will unleash an army of brilliant, talented, motivated entrepreneurs, itching to make their mark on the world. It will strike a blow against cronyism and put a stake in the heart of Too Big To Fail. Nobody epitomizes crony-capitalism more than Goldman Sachs. Perhaps that is why Goldman is attacking Trump's tax plan for being too generous to American small business.
I am a small businessman. After toiling for seven years at a major New York law firm, I started my own practice in 2010 and soon became an advocate for getting the hell out of Big Law and setting up your own shop. Since that time, I have been privileged to advise extraordinarily talented entrepreneurs and early-stage companies in technology, finance, law, real estate, and many other fields. I have co-founded two start-up tech companies and served as Chief Strategy Office for a third. I labor in the vineyards of American entrepreneurism. Every day, I see the guts, genius, courage, determination and ruthlessness of America's entrepreneurs. It is the most exciting arena in the world.
If I could have one wish for my country, it would be for millions and millions of Americans to feel the satisfaction and liberation that comes with creating a business. Those who forsake a secure paycheck to bet on themselves are making a profound statement of human dignity. Starting a business is a declaration of personal independence, a defiant assertion that you (not your employer) own your time and talent. When you muster the backbone finally to refuse your corporate overlord’s unquenchable demand for 70% of the fruits of your labor, it is an act of insurrection in our nation’s finest tradition.
The last decade was rough on small business. In most of the U.S., more small businesses closed than opened. America was built by entrepreneurs and self-starters, but in recent years, the business environment has kept talented people on the sidelines. We have a massive, pent-up entrepreneurial energy across America, including within the ranks of Corporate America.
This proposed tax cut will unleash that pent-up energy. Here is how it breaks down: under current law, if you start your own business, your business income is “passed through” to you personally. So, if your company makes $1 million in net income that is attributed to you personally, you pay personal federal income tax on that amount. For a single individual, you’ll pay about $350,000 in federal tax on $1 million – or about 35%. If you count state and local taxes, you're looking at nearly a 50% tax on small business. Big companies play by a completely different set of rules. Under current law, the tax rate for corporations is 35%, but, of course, big companies lobby for tax shelters and loopholes so that in reality, profitable companies pay only about 13% in federal tax. Our current tax law functions as a small business penalty tax. Under the new proposal, all businesses (small and large) pay a flat 15%. Bottom line: by eliminating the small business penalty, your $1 million small business can keep an extra $200,000 to invest in R&D, make capital expenditures, or hire more workers.
It’s hard to exaggerate how huge that is. It means that during the critical early years of a company, you will be able to reinvest an extra 20% of your profits into your business, rather than throwing it into the black hole that is government. It also means that you will qualify for better credit terms because you will have more after-tax income to support the loan. You can raise money on better terms because your business is automatically 20% more profitable. The biggest impediment for small businesses is access to capital. By allowing a small business to reinvest more of its own profits, you will see a great number of $1-5 million per year businesses become $10-50 million businesses. Imagine sprinkling thousands of these stories across the American economy. That’s the start of a major boom.
The proposed tax cuts will prompt an exodus of Corporate America’s top performers. A bit of economic theory is required to explain why that is so. Economists have shown that about half of a company’s productivity is created by the square root of the total number of employees. This rule of thumb holds true across a wide variety of industries and endeavors. It means that in a company of 9 employees, about 3 employees (33%) will be responsible for half of the production; but in a company of 10,000 employees, about 100 (1%) will account for half of the company’s productivity. Inefficiency grows exponentially as a company grows larger.
Take the banking industry as an example. The 25 largest banks in America employ about 1.2 million workers. But half of the productivity is created by fewer than 5,000 individuals. These are the individuals who control the important business relationships, bring in most of the money, and whose decisions will determine the future of banking.
Some of those 5,000 rainmakers are my clients. I talk to them all the time about starting their own businesses. If they are given the choice between (A) giving 70% of their revenue to the big bank, plus paying 35% in taxes on what remains; or (B) keeping all the revenue and paying 15% in taxes, it's a no brainer. Even for the most risk-averse people, the tax incentive to start a company will be hard to refuse.
When a significant percentage of high producers stop giving the big banks most of their revenue and start their own competing firms, Too Big To Fail will collapse under its own inefficiency. Out of the ashes will emerge a new banking industry, composed of hundreds of reasonably-sized banks eager to serve the rising tide of small and medium-size businesses. The result will be a trend toward smaller, more service-focused banking. If you've dealt with banks in the last 6 or 7 years, that will be a welcome change. This story is not limited to banking, but will repeat itself in one industry after another.
As the Small Business Revolution reshapes the American economy, it will reshape cultural attitudes toward capitalism and self-reliance as well. A recent survey found that only 42% of young Americans have faith in capitalism. That is the legacy of the 2008 financial crisis that taught a generation of Americans that capitalism means bailouts for bankers and misery for everyone else.
The Small Business Revolution will change hearts and minds. When the economy starts roaring and entrepreneurs are allowed to grow, you're going to start to see a lot of successful businesses and a lot of happy entrepreneurs who came by their success honestly. If your friend starts a business, it is more likely that you will start a business. When young people see that small business is not about oppression, but liberation, they will embrace it. When young people hear they can make more money and never dread going to work, they will embrace it. When young people understand that good, efficient small businesses can beat the hell of out of the big, corrupt, inefficient players, young people will embrace the Small Business Revolution. That is how you capture imaginations and change the culture.
We are a nation in turmoil. The next few months will shape America for the next 50 years. We have a once-in-a-generation opportunity to revitalize our economy and create a more energetic, self-reliant, innovative culture. Now we need the political will to carry forward the Small Business Revolution.