When it comes to reporting on the Small Business Administration, it seems to me that most journalists simply assume that if a government agency exists to “help” small businesses then it must be good. So I was pleased to read a weekend piece from two investigative journalists with the Dayton Daily News that challenges the conventional wisdom on the SBA. 

As the reporters explain, the SBA’s main job is to back loans issued by private lenders to small businesses that couldn’t get financing on market terms. The result is that taxpayers end up holding the bag when these naturally riskier loans go bad. 

And quite a few go bad as this Cato essay on the Small Business Administration explains. 

Lenders have little skin in the game so for them it’s heads they win, tails they win. Thus it was shocking – absolutely shocking – that a representative from the SBA and the head of the Ohio Bankers Association provided the reporters with the most favorable quotes.  

The entire piece is worth reading, but the authors did a particularly good job of turning the spotlight on the racket that exists between the SBA, lenders, and national franchisors: 

Franchises are major consumers of SBA loans, according to the Daily News analysis — and sub sandwich franchises top the list. Subway and Quiznos franchises dominated the list of businesses borrowing the government guaranteed loans. Subway franchises took out at least 4,649 of the 7(a) loans since the beginning of 1990, the data show, while Quiznos took out 2,586. 

But the battle of the sub shops went in drastically different directions, according to the loan data. While Subway borrowed more than 2,000 more loans than Quiznos, its loan failure rate was about one-fifth of Quiznos restaurants. Only 4.8 percent of Subway franchise SBA loans were charged off as of the end of February, while almost a quarter — 23.4 percent — of Quiznos franchise loans ended in failure and were discharged to the Treasury. 

Quiznos also led all franchises with $43.5 million in defaulted loan guarantees that SBA had to pay the lending banks. Cold Stone Creamery was second with $29.6 million, followed by Days Inn with $16.9 million and Ramada Inn with $14.3 million.

The sub shops also dominate the nine-county Dayton region in numbers of SBA loans, but the disparity is even more stark. While Subway franchises took out more than twice as many 7(a) loans as Quiznos (35 to 16), only one Subway loan (2.9 percent) failed and was charged off compared to six (37.5 percent) of the Quiznos loans. 

Nationwide, the 50 franchises that cost the SBA the most totaled more than $411 million in discharged loans. 

Corporate franchisors such as Quiznos and Subway contract with individual owners to operate the business, but some corporations take a bigger share of the profits than others.

Quiznos’ cut from its operators makes it harder for them to be profitable, said Robert Purvin, chief executive officer for the American Association of Franchises and Dealers. 

“My bet is lurking behind every failure there is price gouging to the franchisee,” said Purvin. “We’ve been after SBA for years to make no loans to franchisors that are bad players.” 

He said the SBA is essentially subsidizing these big corporate franchisors because the loan money is often used to pay the franchise fees, royalties and sometimes payments on leases controlled by the franchisor. 

What does it say about the state of American capitalism that federal policymakers think it is necessary and proper for the government to subsidize the creation of more Subway shops? 

The defaults and wasted capital aside, it is a quote from the Ohio chapter of the National Federation of Independent Business that gets to the fundamental problem with government-backed lending: 

“Many small business owners see this as an unnecessary program of government intrusion, of picking winners and losers,” said Roger Geiger, Ohio chapter executive director of the National Federation of Independent Business. “They most certainly wonder how equitable it is when it’s their tax dollars being used to fund what could potentially be a competing business.”

As former Sen. Scott Brown (R‑MA) demonstrated a couple of years ago, the average policymaker doesn’t grasp that there are major problems with the federal government picking winners and losers in the market. 

Or else they just don’t care. 

The inconvenient truth is that from the SBA’s inception it has existed for politicians to show that they “care” about small businesses. For politicians who support economic policies that are destructive to businesses small and large, demonstrating support for the SBA allows them to pretend otherwise. 

For this libertarian policy analyst, the annual release of the president’s budget proposal is like the day after your team loses the Super Bowl: everyone’s talking about it, but you’d rather curl up in bed with a fifth of Old Grand-Dad.

Alas, it’s that time of year—albeit a couple months late. The budget won’t be released until next week, but some of the details have leaked out to the press. As Dan Mitchell notes, the Washington Post is “predictably regurgitating” the White House’s spin that the president’s latest budget will be an olive branch of sorts to Republicans.

Why?

The president will apparently propose modest measures to slow the growth in entitlement spending in exchange for more tax increases. That would raise hopes for what the Beltway class likes to refer to as the “grand bargain,” but for those of us who are looking for considerably less government in our lives it would hardly be cause for enthusiasm.

Nor are any of the other ideas being reported:

• Sequestration would be replaced with an alternative deficit reduction package. Expect for that to be higher taxes combined with a promise to cut spending somehow, some day in the future.
• Funding for a new pre-kindergarten program—because (not much of a) Head Start apparently isn’t enough.
• Funding for some initiative to map the human brain. (I would advise against using a politician’s for the model.)

I’m guessing there will be a package of proposed rinky-dink spending cuts—a now-annual tradition started by the previous big spender in the White House. But, of course, overall spending would continue to grow and the government would still remain involved in every facet of our lives.

Are we about to see a new kinder-and-gentler President Obama? Has the tax-and-spend president of the past four years been replaced by a fiscal moderate? That’s certainly the spin we’re getting from the White House about the president’s new budget. Let’s look at this theme, predictably regurgitated in a Washington Post report.

President Obama will release a budget next week that proposes significant cuts to Medicare and Social Security and fewer tax hikes than in the past, a conciliatory approach… [T]he document will incorporate the compromise offer Obama made to House Speaker John A. Boehner (R‑Ohio) last December in the discussions over the “fiscal cliff”—which included $1.8 trillion in deficit reduction through spending cuts and tax increases. …[U]nlike the Republican budget that passed the House last month, Obama’s budget does not balance within 10 years.

Since America’s fiscal challenge is the overall burden of government spending, I’m not overly worried about the fact that Obama’s budget doesn’t get to balance. But I am curious whether he truly is proposing a “conciliatory” budget. Are the tax hikes smaller? Are the supposed spending cuts larger? Actually, there are no genuine spending cuts, since the president’s budget is based on dishonest baseline budgeting. At best, we’re simply talking about slowing the growth of government.

But since Mitchell’s Golden Rule is based on the very modest goal of having government grow

slower than the private sector, it’s possible that the president may be proposing something worthwhile. But possible isn’t the same as probable. Indeed, it appears that the budget is predicated on a giant bait-and-switch, since it would repeal the beneficial spending restraint imposed by sequestration!

Obama’s budget proposal, however, would eliminate sequestration.

This appears almost as an afterthought in the Washington Post article, but it should be the lead story. The White House wants to get rid of a policy that genuinely limits the growth of spending. We won’t have the official numbers until the budget is released next Wednesday, but I’ll be very curious to see whether the supposed spending cuts elsewhere in his budget are greater than or less than the spending increases that will occur if sequestration is canceled—particularly since the president also is proposing lots of new spending on everything from early child education to brain mapping.

Moreover, it looks as if the Obama tax numbers are based on some dodgy math. The White House is claiming that this is a “conciliatory” budget because the president is no longer proposing $1.6 trillion in tax hikes:

The budget is more conservative than Obama’s earlier proposals, which called for $1.6 trillion in new taxes and fewer cuts to health and domestic spending programs. Obama is seeking to raise $580 billion in tax revenue by limiting deductions for the wealthy and closing loopholes for certain industries like oil and gas. Those changes are in addition to the increased tobacco taxes and more limited retirement accounts for the wealthy that are meant to pay for new spending.

Let’s try to disentangle the preceding passage. The president wants $580 billion in new tax revenue from eliminating various “deductions” and “loopholes.” But he also wants an unknown pile of revenue from new tobacco taxes and from restricting IRAs. And keep in mind that he already got $600 billion in new taxes as part of the fiscal cliff deal.

Until we get official numbers, we can’t say anything with certainty, but I’ll be checking on Wednesday to see how much revenue the president intends to grab as a result of the tobacco and IRA provisions. Suffice it to say that I won’t be surprised if the net impact of all his tax hikes is close to $1.6 trillion—especially since he’s also proposing to manipulate CPI data, a change that would generate another $100 billion in revenues.

In other words, the revenue side of his budget likely will be a bait-and-switch scam, just like the spending side is a joke once you understand that he wants to get rid of sequestration.

I hope I’m wrong, but I fear that my concerns will be validated next Wednesday and we’ll see another budget that has no real entitlement reform and more class-warfare tax hikes.

P.S.: The budget approved by the House of Representatives avoided any tax increases and restrained spending so that it will grow by an average of 3.4 percent annually. Not exactly draconian, but that approach does balance the budget in 10 years.

When I read in my local paper, the Sun Gazette (published in Washington’s Virginia suburbs), that the Arlington County Board was planning to raise property taxes, I prepared the chart below. It shows how my own property taxes have risen since I bought a house in 1997 (with my first tax bill, in 1998, set at 100).

I had the following letter published this week in the Sun Gazette: 

[Arlington] County Board members are discussing raising the real estate tax rate by 5 cents. The Sun Gazette on Feb. 28 published a chart showing that the proposed rate was actually higher in 2000 and 2001. But what you didn’t show was the soaring level of real estate assessments. Property taxes are much higher than they were a decade ago. My first Arlington tax bill was in 1998. My 2012 bill was more than double the 1998 rate–about a 127-percent increase. I think that’s true for most Arlington homeowners. It’s not easy to find past budgets on the county government’s Web site, but I would assume that the county’s revenue has gone up approximately as much. So Arlington isn’t hurting for revenue; it’s just itching to raise spending even faster than tax revenue rises. The Sun Gazette quoted County Board member Libby Garvey saying that a 5‑cent tax hike is “a very good compromise.” Not for taxpayers, it isn’t.

This pattern happens in many states and localities, of course: they spend money freely in good times, then run into trouble when the economy or the housing boom slows down. As Chris Edwards told a reporter in 2009, states during the preceding years had “repeated the same mistakes they made in the late ’90s, assuming the good times were going to last forever.” And when the money stops rolling in, they don’t want to cut back–so they decide to raise taxes to keep their revenue and spending at the high levels they reached during the boom.

I’m normally reluctant to write about “depreciation” because I imagine eyes glazing around the world. After all, not many people care about the tax treatment of business investment expenses.

But I was surprised by the positive response I received after writing a post about Obama’s demagoguery against “tax loopholes” for corporate jets. So with considerable trepidation let’s take another look at the issue.

First, a bit of background. Every economic theory agrees that investment is a key for long-run growth and higher living standards. Even Marxist and socialist theory agrees with this insight (though they foolishly think government somehow is competent to be in charge of investments).

Let’s look at two remarkable charts, starting with one that shows the very powerful link between total investment and wages for workers.

As you can see, if we want people to earn more money, it definitely helps for there to be more investment. More “capital” means that workers have higher productivity, and that’s the primary determinant of wages and salary.

Our second chart shows how the internal revenue code treats income that is consumed compared to how it penalizes income that is saved and invested. Simply stated, the current system is very biased against capital formation because of the combined impact of capital gains taxes, corporate income taxes, double taxes on dividends, and death taxes.

Indeed, one of the reasons why the right kind of tax reform will generate more prosperity is that double taxation of saving and investment is eliminated. With either a flat tax or national sales tax, economic activity is taxed only one time. No death tax, no capital gains tax, no double tax on dividends in either plan.

All of this background information helps underscore why it is especially foolish for the tax code to specifically penalize business investment. And this happens because companies have to “depreciate” rather than “expense” their investments.

Here’s how I described depreciation in my post on corporate jets.

If a company purchases a jet for $20 million, they should be able to deduct – or expense – that $20 million when calculating that year’s taxable income… A sensible tax system defines profit as total revenue minus total costs – including purchases of private jets. But today’s screwy tax code forces them to wait five years before fully deducting the cost of the jet (a process known as depreciation). Given that money today has more value than money in the future, this is a penalty that creates a tax bias against investment (the tax code also requires depreciation for purchases of machines, structures, and other forms of investment).

And I also addressed the issue when writing about the economic illiteracy in one of the Obama-Romney debates.

Now let’s see what some experts on the topic have to say.

Here’s some very sage analysis from Alan Viard of the American Enterprise Institute.

…a deal that cuts the corporate rate could end up doing more harm than good. The problem is that Congress and the Obama administration are thinking of pairing the rate cut with a slow-down of companies’ depreciation deductions. That’s a bad combination. A key goal of corporate tax reform should be to reduce the tax penalty on business investment. Investments in equipment, factories, and other forms of capital help power the long-run economic growth that boosts wages and living standards for American workers. …If depreciation is slowed down enough to offset the full revenue loss from the rate cut, then there’s no reduction in the investment penalty, on balance. The depreciation changes take back with the left hand everything that the rate cut gives with the right hand. …In fact, the policy makes the tax penalty on new investments bigger. …Why is this bad combination being considered? Maybe because the rate cut is easy to understand and the harm of slower depreciation is easy to overlook. …Yes, let’s cut the corporate tax rate. But, let’s not slow down depreciation to pay for it.

Amen. Proposals to lower America’s destructively high corporate tax rate are needed, but I don’t want politicians “paying for” the change with other policies that are similarly harmful to growth and competitiveness.

Margo Thorning of the American Council for Capital Formation adds some wisdom with her column in today’s Wall Street Journal.

…proposals that would increase the tax burden on capital-intensive industries—which are contributing to U.S. economic growth and employment—should be viewed with caution. …stretching out depreciation allowances reduces a company’s annual cash flow and raises the “hurdle rate” that new investments would have to meet before they are approved. For capital-intensive firms in sectors such as energy, manufacturing, utilities and transportation, the trade-off between delayed cash flow and lower corporate income-tax rates may result in cutbacks in capital spending. …Each additional $1 billion in investment is associated with 23,000 new jobs, according to data from the Department of Commerce and the Bureau of Labor Statistics. …Rather than drawing out depreciation schedules, a better, pro-growth approach to corporate tax reform would be to allow all investment to be expensed—in other words, deducted from income in the first year.

I share Margo’s concerns, which is why I’m very suspicious when the President says he wants to lower the corporate tax rate and “reform” the system.

Last but not least, Matt Mitchell (no relation) of the Mercatus Center recently added his two cents to the discussion.

The idea that “accelerated” depreciation is a loophole can be traced back to Stanley Surrey, the Harvard law professor whose work in the 1950s, 60s, and 70s influenced many…, including Senator Bill Bradley. …immediate expensing would mean abandoning “the attempt to tax business income.” That’s because it would essentially turn the corporate income tax into a corporate consumption tax. And that may be a good thing. Capital taxation is notoriously inefficient. This is one reason why Robert Hall and Alvin Rabushka permitted immediate 100 percent expensing in their famous flat consumption tax.

You should realize, by the way, that the distorted view of what’s a loophole doesn’t just apply to depreciation. The Joint Committee on Taxation (the same folks who basically assume that the revenue-maximizing tax rate is 100 percent) also tells lawmakers that it’s a loophole if you don’t double-tax capital gains, or if you allow people to avoid double taxation by utilizing IRAs.

With advice like that, no wonder the tax code is a mess.

Anyhow, congratulations are in order. If you’ve made it this far, you almost surely know more about depreciation than every single politician in Washington. Though, to be sure, that’s not exactly a big achievement.

Back in 2010, I wrote a post entitled “What’s the Ideal Point on the Laffer Curve?”

Except I didn’t answer my own question. I simply pointed out that revenue maximization was not the ideal outcome.

I explained that policy makers instead should seek to maximize prosperity, and that this implied a much lower tax rate.

But what is that tax rate, several people have inquired?

The simple answer is that the tax rate should be set to finance the legitimate functions of government.

But that leads to an obvious follow-up question. What are those legitimate functions?

According to my anarcho-capitalist friends, there’s no need for any public sector. Even national defense and courts can be shifted to the private sector.

In that case, the “right” tax rate obviously is zero.

But what if you’re a squishy, middle-of-the-road moderate like me, and you’re willing to go along with the limited central government envisioned by America’s Founding Fathers?

That system operated very well for about 150 years and the federal government consumed, on average, only about 3 percent of economic output. And even if you include state and local governments, overall government spending was still less than 10 percent of GDP.

Moreover, for much of that time, America prospered with no income tax.

But this doesn’t mean there was no tax burden. There were federal excise taxes and import taxes, so if the horizontal axis of the Laffer Curve measured “Taxes as a Share of GDP,” then you would be above zero.

Or you could envision a world where those taxes were eliminated and replaced by a flat tax or national sales tax with a very low rate. Perhaps about 5 percent.

So I’m going to pick that number as my “ideal” tax rate, even though I know that 5 percent is just a rough guess.

For more information about the growth-maximizing size of government, watch this video on the Rahn Curve.

There are two key things to understand about my discussion of the Rahn Curve.

First, I assume in the video that the private sector can’t provide core public goods, so the discussion beginning about 0:33 will irk the anarcho-capitalists. I realize I’m making a blunt assumption, but I try to keep my videos from getting too long and I didn’t want to distract people by getting into issues such as whether things like national defense can be privatized.

Second, you’ll notice around 3:20 of the video that I explain why I think the academic research overstates the growth-maximizing size of government. Practically speaking, this seems irrelevant since the burden of government spending in almost all nations is well above 20 percent-25 percent of GDP.

But I hold out hope that we’ll be able to reform entitlements and take other steps to reduce the size and scope of government. And if that means total government spending drops to 20 percent-25 percent of GDP, I don’t want that to be the stopping point.

At the very least, we should shrink the size of the state back to 10 percent of economic output.

And if we ever get that low, then we can have a fun discussion with the anarcho-capitalists on what else we can privatize.

P.S. If a nation obeys Mitchell’s Golden Rule for a long enough period of time, government spending as a share of GDP asymptotically will approach zero. So perhaps there comes a time where my rule can be relaxed and replaced with something akin to the Swiss debt brake, which allows for the possibility of government growing at the same rate as GDP.

You know you’ve arrived when your name starts showing up in cartoons. Here’s the Wall Street Journal’s legendary “Pepper … and Salt” cartoon from last Thursday:

Of course, most inflation obsessives are deficit scolds, so it’s not clear that host is going to get much debate. 

One person who might be called both an inflation obsessive — that is, a person who objects to the robbery of savers through the erosion of the value of their money — and a deficit scold is David Stockman, former budget director for President Ronald Reagan. He has a new book out, The Great Deformation: The Corruption of Capitalism in America, which he summarized in the New York Times on Sunday. He’ll be speaking about his book at the Cato Institute on Wednesday. Don’t miss it.