Competencies and Institutions Fostering HGFsMagnus Henrekson, IFN

Based on joint work with Dan Johansson forthcoming inFoundations and Trends in Entrepreneurship 9(1), 2009

November 2008

Motivation and purpose• Gazelles/HGFs by some found to contribute

disproportionally to growth and job creation– Seems to be the case in the U.S.– But generally less true in Europe

• What institutional conditions most likely to be conducive to HGFs?– Talented entrepreneurs supply effort– Incentives to expand if potential– Harmonization of diverse competencies and agents

• Identify key agents

Key agents: the competence bloc• Entrepreneurs

• Inventors and Innovators

• Industrialists

• Skilled labor

• Venture capitalists– Business angels– VC funds

• Agents on the secondary (exit) market

• Competent customers

Build large industrial firm

VC agents

Skilled labor

Development of viable idea

Commercial-ization

Competent customers

IndustrialistsEntrepreneurs

Entrepreneurs

InventorsEntrepreneurs

Agents on secondary markets

The Competence Bloc

Rich countries: Why conditions for HGF?• Bartelsman et al. (2005): “Firms in the U.S. enter

with a smaller employment size than their counterparts in Europe but, if successful, expand much more rapidly to reach a higher average size.”

• Sternberg and Wennekers (2005): “These findings may have important implications for entrepreneur-ship policy in highly developed economies. At least from an economic growth perspective, policy should focus primarily on potentially fast growing new firms and not new enterprise in general.”

The tax code

• Key rates and schedules insufficient to characterize the tax code

• Tax code does not acknowledge categories in Competence bloc (income from e-ship etc)

• Key agents interact in complex ways; details in the tax system likely to be of great importance

Different taxes and their effects

Labor taxation

• level and degree of progressivity

• EITC/exemptions

• social security contributions– level and degree of actuarialness– capped/non-capped/differentiation

Sales/consumption taxation

• degree of uniformity

• exemptions

Taxation of current capital income• dividends

• interest income

• exemptions

Capital gains taxation• uniform/progressive

• differences across assets

• differences based on holding period

Taxation of stock options

• capital or labor income?

• tax on realized or imputed gain?

• tax due at receipt of option, when stock called or when stock sold?

• differences based on holding period

• effect of employment clause

Corporate taxation

• statutory rate• S-corporations or other measures to eliminate

two-tier taxation• accounting measures to lower effective taxation • treatment of holding companies

– domestic/foreign• single- or multi-level taxation

Taxation at owner’s level

• differential across types of owner

• exemption levels/threshold effects

• VC/PE firm taxation

Taxation of asset holdings

• wealth tax/property tax

• Inheritance/gift tax

Taxation of return on savings

• differences across instruments

• preferential treatment of pension savings

• differences across agents

Effective marginal tax rates for different combinations of owners and sources of finance: Sweden 1980 (real pre-tax return 10%).

Debt New share issues

Retained earnings

1980

Households 58.2 136.6 51.9

Tax exempt institutions

–83.4 –11.6 11.2

Insurance companies

–54.9 38.4 28.7

and in 1994

Debt New share issues

Retained earnings

1994

Households 27.0 18.3 26.5

Tax exempt institutions

–14.9 21.8 21.8

Insurance companies

0.7 32.3 33.8

Corporate Tax Rates and Corporate Tax Payments as a Share of GDP in OECD Countries 2000 (%)

0

10

20

30

40

50

60

Luxemburg

Australia

NorwayFinland

Portugal

Netherlands

Canada

New Zealand

SwedenIre

landKorea

Belgium UKIta

lySpain

Switzerla

ndU.S.A.

Denmark

Turkey

Hungary

AustriaIceland

Germany

Tax rate

0

1

2

3

4

5

6

7

8

Tax paymentsas a share of GDP

Tax rate

Tax payments

Labor market institutions• Enormous churning (every 7th job disappears every year)

• Wage-setting arrangements– degree of centralization and formalization

– miminum wage laws

– wage compression ”deprofessionalizes” service sector

• Labor security mandates weigh more heavily on smaller and younger firms and on those with high business risk (HGFs)

• Labor security mandates hamper the reallocation of workers, jobs and capital

• High compensation for irregular work schedules, strict seniority rules and employment security, and responsibility for rehabilitation etc. disfavor many service industries with many potential HGFs

Product market regulations • Many product regulations. We deal with/analyze

regulations disturbing the the entrepreneur-customer link, by restricting market entry by private entrepreneurs and by restricting private customers’ ability to choose a (private) provider.

• The less certainty and political stability the more it benefits large incumbent firms.

• The extent to which sectors of high income elasticity of demand are open for private production and private purchasing power: education, personal care and health care.

Three types of regulations(i) production is contestable, but only

government financing of purchases is allowed;

(ii) production is monopolized by government, but private financing is allowed; and

(iii) production is monopolized and financed by government.

The benchmark case is private production and private financing

Product markets and the prevalence of competence blocs and HGFs – most important effects

Private prod. Monopolized prod.

Private finan-cing

Complete competence blocs and prevalence of HGFs

Entrepreneurs – NoVenture capitalists – NoCompetent customers – Limited

No competence blocs, no HGFs

Publicfinan-cing

Competent customers – Limited

Likely impediments to competence blocs and to HGFs

Entrepreneurs – No Venture capitalists – NoActors in secondary markets – No

Competent customers – NoNo competence blocs, no HGFs

Design of the savings and social insurance systems etc

• Degree of institutionalization– Design of pension systems: public and private– Tax favoring of certain kinds of saving?

• Social benefits tied to current employment? – The degree of actuarialness of firm-based

complementary systems

• ”Soft” government?– Intermediate size firms likely to suffer the most

Institutions Favoring Sclerotic Capitalism or Dynamic Capitalism

Institutions Sclerotic capitalism

Dynamic capitalism

Marginal tax rate high low

Personal tax on capital income

high low

Personal tax on capital gains

high low

Tax on stock options

high low

Degree of tax neutrality across owner categories

favor institutions over individuals

neutrality

Institutions Sclerotic capitalism Dynamic capitalism

Degree of neutrality across sources of finance

favor debt over equity neutrality

Personal taxation of asset holdings

yes, in particular on equity

no, or exemption for equity holdings

Corporate tax rate high statutory rate, low effective rate and exemptions favoring large firms in mature industries

low statutory rate, low effective rate and neutral across types and firms and industries

Symmetric tax treatment of profit and losses

no yes

Labor security mandates

tied to years of tenure portability of tenure rights

Institutions Sclerotic capitalism

Dynamic capitalism

Design of pension plans

large weight to best years at high age

fully actuarial

Wage-setting arrangements

centralized, tied to formal criteria

decentralized and

individualized

Production of welfare services

government production

sizeable private prod., contestability

Financing of welfare services/merit goods

tax financing only government ensures basic supply, then private financing

Profit-driven organizations

partly prohibited in key areas facing income-elastic demand

fully allowed

Government role in income insurance

impose obligations on incumbent firms

provide flexicurity

Conclusions

• HGFs/Gazelles key to growth and job creation

• Many complementary competencies and agents in complex interaction to take firm from small to large

• Impossible to pick winners ex ante

• Key institutions to harmonize incentives– The tax system: have to get the details right!– Labor market regulations and wage-setting institutions; do not tie

entitlements to long-term tenure– Savings systems and social insurance as facilitators– Product market regulations enabling entrepreneurial process and

product innovation