Excessive Regulation And Taxation Hinder Small Biz Recovery

By Bradley Scott
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Law360 (May 18, 2020, 5:58 PM EDT) --
Bradley Scott
Bradley Scott
It is widely known that most small businesses fail in the first five years. Those that survive are heralded by politicians as they seek office.

Yet once those same politicians are in office, their policies invariably create greater challenges to the small businesses they once courted. The political response to COVID-19 in recent months has exposed the disconnect between the messaging of candidates and their actions once elected.

Politicians speak about small businesses like they are different than large corporations — and they are right to do so. Policies written with large corporations in mind do not transfer easily to the small business world, yet our elected officials routinely try to apply a one-size-fits-all approach to governance.

Small businesses do not have the resources or bandwidth to behave like large corporations. For a successful recovery, small businesses will need regulatory and tax policies that match their resources.

Barriers to a strong small business recovery include, but are not limited to, harmful coronavirus-related legislation and executive orders, licensing requirements that distort markets, ever-increasing reporting requirements, and the expansion of nexus-based governance, which initially targeted remote sales tax, but has crept into direct taxes and other cross-border regulations.

Harmful Legislation and Executive Orders

It is not the coronavirus that is hurting small businesses, but the political response to it.

The Families First Coronavirus Response Act, or FFCRA, and the Coronavirus Aid, Relief, and Economic Security, or CARES, Act have amplified the challenges small businesses face, and the shutdowns have all but sealed the fate for many.

The argument that we had to make a choice between life and the economy is false. To be clear, it is a deadly disease. But news out of China and Italy earlier in the year supported the fact that underlying health conditions greatly influenced the outcome for those who caught the virus.

There could have been a balanced approach that respected the sanctity of life and prevented widespread economic collapse. But rather than crafting a response tailored to protect the vulnerable, politicians instead downplayed COVID-19's severity.

Once it was too late to take that course of action, economically disastrous shutdowns were enacted, effectively killing commerce for millions of small businesses. Social distancing was rapidly replaced by widespread executive orders to shelter-in-place.

By mid-March, as one report after another announced suspensions, closures and other COVID-19-related government reactions to the fact that COVID-19 was in our midst, people across the country panic-shopped, preparing to hunker down for a few weeks.

We watched as sales at our own small business shrank by 75%. Talks of closing the economy made planning anything nearly impossible. Like many other small businesses, we had to take decisive action with little actual knowledge about the disease or the coming response from our government.

Then, in the face of potential government-mandated closures, we learned that we would have to pay our staff if they could not work. The FFCRA mandated that small businesses pay employees sick leave for coronavirus-related absences, disregarding the possibility that small businesses may already have had paid-time-off policies in place.

We could recoup this expense through confusing payroll tax credits, but the credits amount to only a fraction of payroll total and involve a process that could take months.

The FFCRA effectively told small businesses to check their balance sheets and make sure they could cover two to 12 weeks of paid coronavirus-related leave, potentially for their entire staff.

Even during the best of times, managing an unfunded expense of this nature is not realistic, let alone in the midst of a government-enforced shutdown. Though undoubtedly an unintended consequence of the bill, Congress inadvertently told small businesses to let their people go.

The CARES Act was another shortsighted congressional response. Intended to ease the burden of the FFCRA, it has instead become a confusing succession of shifting guidelines.

And while Congress all but ensured mass layoffs with the passage of the FFCRA, governors compounded the economic crisis with executive orders forcing shutdowns that disproportionately affected small businesses, hammering in what will for many surely be a coffin nail.

Congress could have used its power to get financial assistance directly to affected workers by fully funding a national emergency unemployment program. Would it have been a nightmare? Most definitely.

But since its passing, the CARES Act has created many other nightmares. Increased U.S. Small Business Administration lending in the form of the Paycheck Protection Program, or PPP, sounded good in the news. It gave legislators the opportunity to tell their constituents they were looking out for small businesses and their employees.

Two obvious shortfalls of the PPP loan program were that businesses delayed making critical, time-sensitive staffing decisions as they waited for funding, and that the program was exploited.

Businesses fund payroll through cash flow. While waiting on the SBA PPP loans to be funded, small business owners burned through savings, not revenue, to pay staff.

For businesses that did not secure a PPP loan, those savings should have been reserved for inventory and supplies when they could reopen. Now those business owners are broke, and their employees are applying for unemployment insurance anyway.

Due to mismanagement at many levels of government, more than 36 million jobs have been lost and the number continues to grow. An unknown number of small businesses have been permanently wiped out.

Those workers and business owners are now left wondering how they will pick up the pieces of their lives, and how to move forward in a still collapsing economy.

More problems will follow. As layoffs mount, company-sponsored health insurance benefits expire. Under normal circumstances, history tells us that economically fragile people have higher mortality rates, particularly when they have limited or no access to medical care.

Discussions of a second wave of coronavirus dominate the reasoning behind the delay in reopening the economy. Again, this is proposing that there is a binary choice between life and the economy.

I would argue that there is another, different, second wave coming. The majority of the 36 million people who have already filed for unemployment were not working remotely. They were the first to be cut, but they will not be the last.

As revenue dries up, fewer businesses will need the services of those who work remotely. Suddenly, the terror that our service industry workers, our retail workers and our factory workers already know will become familiar to those remote workers who thus far have been spared.

There will be a third wave as well. As government workers are forced to adjust to smaller government budgets, they too will feel the sting of unemployment.

The economy, for better or worse, runs on the productivity of people's labor. If labor stalls long enough, the supply chain fails, leaving no corner of the workforce safe from cuts.

Government-Sponsored Market Distortions

Supply and demand are not the only factors that will drive our nation's recovery. Regulation and taxation will be equally influential. And while supply and demand drive activity, regulation and taxation stifle it.

Now, more than at any point in recent memory, government agencies need to step aside and give the people the best chance to drive a strong economic recovery. Barriers to entry, to growth and, ultimately, to success need to be lowered or removed entirely.

The first barrier to entry many entrepreneurs face is licensing. License requirements and fees vary from state to state and even city to city.

It is preposterous to tell a plumber from Minnesota that they are not qualified to perform their profession in California because they lack a Californina license, yet there are laws on the books that say just that.

The common argument is that a local license proves a satisfactory level of professionalism. In truth it serves as a barrier to entry for those who are unlicensed, and is a form of state-sponsored protection for those who are licensed.

Millions of self-employed professionals face these constraints, limiting their ability to migrate to markets with stronger demand and economic potential. Licensing requirements should be more uniform, allowing for freer movement.

The Technology Myth

Barriers to entry are not the only hurdles small businesses face. As micro-businesses graduate to small businesses, they often find there are new, additional government agencies to which they must report.

At the local and even state level, this is not unusual. However, as more businesses grow up with an online presence, state and local governments are looking further and further abroad to find revenue.

Our 22-person company currently reports to 30 states, despite the fact that we operate solely out of the state of Arizona. If the Organization for Economic Cooperation and Development has its way, we will also be reporting to foreign countries.

There is a common misconception among politicians that highly sophisticated technology and big data remove regulatory burdens. Lobbyists from technology firms, and large corporations with the resources to manage large numbers of federal, state, and local legal obligations, reinforce this misconception in the echo chambers of Capitol Hill.

The small businesses that are hurting the most right now do not have those resources. And yet those small businesses, often located in a single locality, are ensnared by the same rules, regulations and taxation barriers that larger businesses are able to manage.

Expansion of Nexus-Based Governance

The term "nexus opportunism" has taken root with American policymakers. It is the idea that because a business has sold a product in a taxing district, it has somehow created a taxable — or regulation-worthy — relationship with that district.

State and local governments are extending their tax base and regulatory reach based on remote economic activity, in the pursuit of greater access to new revenue sources.

Ultimately, these actions will limit the potential of millions of small businesses, and hinder small-business recovery from the current economic crisis. The corollary is that these actions will benefit the corporate giants.

Prior to the U.S. Supreme Court's 2018 decision in South Dakota v. Wayfair Inc., states were prohibited from forcing small businesses with no in-state physical presence to collect sales tax.

The Supreme Court overturned decades of precedent in Wayfair, by allowing economic nexus to become the new standard allowing state taxation. In doing so it put the future of countless businesses at stake.

Unfortunately, many states are unwilling to work together to create a nationwide, interstate sales tax regime that prioritizes uniformity, simplicity and consistency over local preference. As a result, small companies spend a disproportionate amount of money and time trying to comply with a tax regime that offers no benefit in return.

For the sake of small businesses, a national standard needs to be set so that valuable time and financial resources can be put into growth rather than compliance.

Congress was afforded the opportunity to address remote sales tax, first in 1992 following the Supreme Court's decision in Quill Corp. v. North Dakota, and again after the Wayfair decision. On both occasions, it opted to punt.

This failure to act, not once but twice, has small businesses operating in fear of 46 departments of revenue. The fear stems not from an unwillingness to comply, but from knowledge that the system is so complex that compliance is almost impossible. Compliance rates would most likely increase if the regime were less onerous.

Not Just Sales Tax

In 1959, the federal government sought to protect small businesses from aggressive state taxation where there was no physical presence by passing Public Law 86-272, which prevented income taxes on activities limited to the solicitation of sales on tangible personal property. In essence, Congress said that selling goods across state lines did not generate an income tax liability, provided that a business had no other activity in a state.

Unfortunately, income tax is not the only tool a tax collector has. Top line taxes, also referred to gross receipts, commercial activity, franchise, business and occupation, etc., are not expressly forbidden, allowing states to assess a direct tax against a business with no access to local services.

What's more, top line taxes are assessed against sales, not profits. This has the effect of taxing a business whether or not it is profitable. This disproportionately hurts small and new businesses.

PL 86-272 should be bolstered to include a prohibition on all direct taxes where a business has no physical presence in a state.

On the heels of the Wayfair decision, California passed the California Consumer Privacy Act, another law that reaches beyond state borders. Businesses with an online platform must now follow California laws concerning consumer data privacy.

Massachusetts introduced the Massachusetts Consumer Data Privacy Act in 2019, a bill with similar intent, yet different requirements, to California's CCPA.

Again, for the sake of small businesses, a national standard needs to be set so that valuable time and financial resources are put into growth as opposed to compliance.

Governments Are Putting the Brakes on Their Own Small Businesses

These are but a few of the barriers to growth prohibiting small businesses from graduating to the next level. Increased regulatory and tax burdens stunt business development, as resources are diverted from growth and job creation into compliance efforts.

Historically, as small businesses grew into larger corporations, their legal footprint became larger. As they expanded into new jurisdictions, they did so cognizant of those jurisdictions regulatory and tax regimes. They made decisions to expand as their resources allowed, increasing their legal obligations at their own pace.

As nexus provisions become common, there is a new brand of expansion. Small businesses are no longer growing into new jurisdictions — those jurisdictions are descending upon them, crushing them. And while large corporations grew organically, small businesses wilt.

Our nation is based on federalism, whereby the states have the right to govern themselves while not burdening interstate commerce. This notion has been forgotten as states flex their individual muscles.

That flexing is choking the small businesses politicians frequently refer to as the engine of our economy. With COVID-19 as the backdrop, the economy is being strangled. It is time to release the chokehold and let small businesses work again, free from disparate rules, regulations and tax policy from far flung state capitols.

It is often said that small businesses are the backbone of the American economy. Well, our back is breaking. Ironically, government regulation and taxation are the source of the strain.



Bradley Scott is director of finance at wholesale jewelry supply company Halstead Bead Inc.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the organizations or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

For a reprint of this article, please contact reprints@law360.com.

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