The Indispensable Succession Plan
November 29th, 2007 | Posted by innovNow that the dust has settled on the recent tumult in the C-suites of Merrill Lynch and Citigroup (BusinessWeek.com, 11/27/07), one thing is clear: Boards need to have a credible, specific, and actionable chief executive officer succession plan in place at all times.
The lack of such a plan—which appears to have been the case at two of the world’s highest-profile financial services firms—destroys credibility in the capital markets and erodes shareholder value. It also stirs anxiety inside the companies involved, making it difficult for people to stay focused and maintain momentum. Boards that fail to have a decisive succession plan at all times, whether it’s for an emergency or planned retirement, run the serious risk of being judged negligent in the court of public opinion.
The problems at Merrill Lynch (MER), which had to scramble to find a successor to Stanley O’Neal, and at Citi (C), which is still searching for a new chief executive, make the point. But you can easily find other examples. Kmart (SHLD) and Apple (AAPL) (before Steve Jobs returned) each had four consecutive CEOs who failed. Harder, but not impossible, to find are examples of boards being prepared. (When health tragedies struck two consecutive CEOs of McDonald’s (MCD) in 2004, the board’s robust succession plan came through.)
Why are so many boards so bad at what, by definition, is one of their most important jobs? As someone who has spent his entire professional life studying corporate leadership in all forms, it seems to me there are two fundamental reasons:
1. Boards don’t take succession seriously enough. They assume that if the CEO is new, is performing well, or is several years from retirement, succession can wait. Urgent and routine matters eat up time, and succession slides to the bottom of the agenda. Or else the boards rely on the CEO to carry the weight. So, for example, when the CEO says the potential successor won’t be ready for four or five years, the board is too polite to push the issue. Regardless of the current CEO’s age or status, succession should be a constant and urgent concern.
2. Boards don’t think through the constantly changing criteria for the CEO job. The world is in continuous flux, and so are the challenges a chief executive faces. The board must periodically revisit and perhaps change the mix of criteria by which leaders are put on—and stay on—the short list of potential CEO successors.
Succession is a hands-on activity. Boards have to own it, not just by saying that they do, but by digging in and getting engaged in the details. It cannot be delegated. Delegation is abdication when it comes to succession planning.
Boards should discuss succession in depth at least two times a year. Board members should know who the potential candidates are—not only who might be the next CEO but also who could be the CEO after that. (What happened at McDonald’s shows the importance of such in-depth planning). They need to know how each candidate is progressing. They should get to know the candidates formally, through boardroom presentations, and informally, at the dinner table or on the golf course. That way, directors can form their own opinions of the candidates rather than rely solely on the CEO’s.
Directors should also be prepared to suggest ways to help the candidates grow. Say those one-on-one meetings reveal that a candidate is weak in operating experience. The board might suggest a move to test (and preferably improve) that area.
The concept of “fit” is paramount. The board must have knowledge of the current non-negotiable requirements of the job, and the potential CEO’s experiences and natural skills. If the two are not in sync, the board will soon be looking for yet another chief executive. Boards shouldn’t assume that leaders who have performed spectacularly elsewhere can be winners at their company, too. What’s right for another company is not necessarily right for yours.
Take the current situation at Citigroup. Here is my assessment of the non-negotiable criteria the next CEO should meet (in addition to the customary leadership traits of high integrity, high energy, presence, and ability to communicate):
• Credibility, both internally and externally. Employees must believe the new CEO is the right person for the job, and so too must capital markets, investors, and customers. If people inside don’t think the CEO is capable of creating a disciplined process for getting things done, the person will have an uphill battle getting people motivated and aligned. There could even be a talent drain. Doubts in the capital markets about the leader’s capability could quickly cause liquidity problems. This week’s $7.5 billion Abu Dhabi investment was a show of confidence in this fine institution. The right leader must deliver on this confidence.
• The ability to quiet the waters. Citigroup needs a leader who exhibits maturity, confidence, and self-control, who thinks things through for the short and long term, and makes reasoned judgments. Such a leader will have a calming effect on frayed nerves both outside and inside the company.
• Demonstrated ability to cut through the complexities of the capital markets. Having the intelligence to understand the capital markets is just one part of it. The next CEO must have the judgment and courage to crystallize the three to five most critical issues and priorities to focus on in the coming months and years. How well the CEO sorts, sifts, and selects is crucial. He or she must have the intellect and psychological courage for it.
• Ability to manage risk, which is inherent in financial services. The CEO has to have sufficient domain expertise to identify it, and experience in managing it.
• An eye for grooming leadership talent. Citigroup’s success depends on more than just the person at the top. The next CEO must be prepared to build Citigroup’s future by spotting the next generation of leaders, and in particular, by grooming future CEOs.
Given these criteria, it is only fair to ask how well the company’s interim CEO, Win Bischoff, measures up.
I have never met him, but I have talked to many leaders with whom he has worked. I’ve cross-checked his qualities behind the scenes, and this is what people—who have traded candor for anonymity—have told me: He is a person with the highest integrity, a man who is a master of global capital markets with vast international experience. He has the ability to get to the essence of complex issues through incisive questioning. He has deep experience in designing and managing risk. And he is a steady hand who has a calming effect on those who work with him. He seems to be a good match against the criteria.
But there may be others who might be even better. It is incumbent on the board to find out, and I have no doubt it will. Four members of the Citigroup board—Alain J.P. Belda, Alcoa (AA); George David, United Technologies (UTX); Anne Mulcahy, Xerox (XRX) and Richard D. Parsons, Time Warner (TWX) are CEOs who have strong succession plans in place within their own companies.
Pressure on the board compounds when it has to make a crucial decision under an intense public spotlight. The lesson for other boards is to treat succession as urgent. Directors must ask themselves: Do we have a very clear, very specific succession plan? If the answer is no, the board then must ask what it is prepared to do about it, and by when. Such an important matter shouldn’t be left to a committee. Staying on top of this issue is a key responsibility for each and every board member.
November 28th, 2007 | Posted by innovMost all of us are familiar with the concept of “the edge”—and not only because we’re fans of U2′s superb guitarist who goes by that name. Edges are the peripheries of the global business environment, the places where innovation potential is the highest. In today’s fast-moving business world, playing on the edge increasingly is the best way to gain an edge.
Edges define and describe the borders of companies, markets, industries, geographies, intellectual disciplines, and generations. They are the places where unmet customer needs find unexpected solutions, where disruptive innovations and blue oceans get birthed, and where edge capabilities transform the core competencies of the corporation.
Edges are increasingly significant as the global business environment speeds up. In a world of accelerating change, what’s born on the edge transforms the core with breathtaking speed. A few short years ago, both India and China were marginal players in the global economy. Now they are central players. Not long ago, the Internet was a specialized communication platform for scientists. Now it’s a center for commerce and advertising.
Only yesterday, it seems, teenagers stayed in touch outside of school on the telephone or at the mall. Now they log in to a growing number of social networks. Until lately, derivatives and hedge funds were marginal players in the financial marketplace. Now they shape market movements on a daily basis. These examples make a fundamental lesson clear: Embrace your edges or fall quickly behind. Companies avoiding the edge will find their core markets and capabilities under attack from edge players who can deliver more value at lower cost.
Edges are powerful sources of business innovation because they are places of potential and friction, where traditional products and practices are no longer adequate to address unmet needs or unexploited potential. Much tinkering and experimentation occurs on the edge, as well as heated debate about the most promising options to address emerging needs, intensified by the diverse backgrounds, skill sets, and perspectives of participants gathering on the edge. By playing a part in this experimentation, companies participate in rich flows of new knowledge, flows that are the primary sources of innovation.
Edges tend to be risky places: There are no well-established road maps. Order, to the extent it exists, routinely dissolves into chaos, only to reform again in a very different pattern. Market meltdowns and business failures are commonplace. Relationships form quickly on the edge, because people have less confidence in going it alone and are more inclined to seek out others to help them sort through the challenges and share the risks and opportunities created by edges.
Recall Bill Gates in the early days of the personal-computer industry, harnessing a fundamentally new technology on the edge of a more traditional computer industry that dismissed these new products as “toys.” Or consider the host of companies in China and India seeking to reconceive products and processes to serve consumers more effectively in emerging economies at unbelievably low price points. Or think of the early wave of entrepreneurs who saw an opportunity to harness electronic networks to support social networking, especially targeting the desire of a younger, more computer-literate generation to connect with one another in richer ways. Or think of Apple’s (AAPL) iPod, which emerged on the edge of a number of industries, including consumer electronics, music, and the Internet.
Some early and very promising initiatives to harness innovation at the edge of the firm have already been set in motion. For instance, open innovation and so-called co-creation. But these are a small part of a much broader set of edge innovation opportunities, ranging from tapping into the unique dispositions of younger generation employees, who are more “questing” or adventurous as a result of playing online games, to using management practices developed in emerging economies to mount attacker strategies on incumbent companies in the West—a process called innovation blowback.
In future columns, we’ll look at these opportunities and the management practices and institutional arrangements required to harness their potential. We’ll also investigate the information technology platforms that help companies get the most out of their edge initiatives.
For now, we’ll leave you with some bottom-line guidelines for venturing out on the edge:
• Engage. Too often, executives get intrigued with the edge and arrange field visits to explore this strange terrain. Insight rarely comes from such casual visits. Instead, executives need to identify and focus on challenging business issues to engage edge participants productively and drive real insight.
• Sustain relationships on the edge. A lot of the current effort in open innovation focuses on short-term transactions to gain access to existing resources. To get the full value of the learning that’s occurring on the edge, executives need to find ways to build long-term, trust-based relationships with edge participants.
• Bring the edge to the core. In too many cases, companies set up remote outposts on the edge that become isolated and alienated from the core of the business. Senior executives need to identify challenges confronted by the core where insights from the edge can be helpful and sponsor initiatives to bring participants from both domains together around these issues.
These broad guidelines have many specific implications this column will explore as we help you get edgier and edgier about innovation.
Time’s Running Out for Tax-Saving Steps
November 12th, 2007 | Posted by taxBy Daks, Martin C
Publication: NJBIZ
HEADNOTE
MORRISTOWN
Many opportunites are still available, but companies will have to act fast
BUSINESS OWNERS WHO held off on their 2007 tax planning may still be able to take some actions to trim their state and federal tax bills. But experts say time is rapidly
running out since many tax-saving steps must be implemented by Dec. 31.
“Putting away money for your retirement is a great way to take care of your future while reducing your tax liability,” says Jay Trien, senior partner of Trien Rosenberg Rosenberg Weinberg Ciullo & Fazzari LLR a Morristown-based CPA firm. “One kind of retirement plan in particular, a 401 (k), can be a very good vehicle for sole proprietors who don’t have any employees, or for businesses that mainly employ family members,” Trien says.
Named after a section of the federal tax code, 401 (k) plans typically consist of contributions from employees’ pretax incomes plus contributions from employers that reduce workers’ taxable incomes.
Congress continues to focus on tax-shelter activity
November 11th, 2007 | Posted by taxBased on a recent spurt of legislative activity, Congressional Democrats believe that corporations and wealthy individuals are sheltering taxable income from the federal government at an alarming rate. Despite evidence that tax-shelter activity is down significantly over the past decade, many Congressional leaders
perceive an ongoing problem. Congress is now eyeing legislative proposals to codify the “economic substance” doctrine, and to punish companies with subsidiaries engaging in business activities in “tax haven” countries.
The economic substance doctrine is not new. U.S. tax courts have long understood the importance of evaluating whether businesses are engaging in business transactions for sound economic reasons rather than to lower their tax bills. To help do this, the courts created–and subsequently developed–both an “economic substance” test and a “business purpose” test.
Congressional leaders believe these judicially created tests are too narrow, and have embraced more comprehensive–and vaguely worded–legislative language. As passed by the Senate Finance Committee, the economic substance provision would establish a two-part test on economic substance. The taxpayer must establish that (1) the transaction changes in a meaningful way the taxpayer’s economic position; and (2) the taxpayer has a substantial non-federal tax purpose for entering into the transaction.
The proposal is problematic for several reasons. First, it would impose a strict liability underpayment penalty of 30 percent on transactions lacking economic substance. Given that economic substance and business purpose are inherently imprecise, subjective determinations, the penalties are overly harsh. Second, the proposal requires demonstration that the transaction be a reasonable means of accomplishing the taxpayer’s non-tax purpose–but there are no guidelines on how this requirement should be interpreted and applied.
Similarly, several legislative proposals have been introduced this year to address perceived abuses involving “tax haven” countries, whose usage, proponents contend, reduces federal revenues by approximately $100 billion. To this end, Sen. Byron Dorgan (D-N.D.) has introduced a bill (S. 396) to treat certain controlled foreign corporations located in specified tax haven countries as domestic corporations for federal tax purposes.
November 2nd, 2007 | Posted by innovEditor’s Note: In her farewell column, longtime contributor Michelle Nichols offers advice you can apply to selling and to life in general.
A few months ago, my gut started screaming at me to stop writing this column. At the time, that seemed as crazy as not breathing. I’d been writing Savvy Selling for six years and I still had plenty of interesting sales topics left to explore. However, I respect my intuition because it represents 40-plus years of life experience. I’ve learned that whenever I ignore its guidance, I have regrets.
I’m not one to casually walk away from a great relationship. Through my columns, I was able reach more folks around the world in a month than I could speak to in a lifetime. Helping readers sell more and building friendships in the process (I made friends in over 50 countries) have been my favorite parts of the process.
Six years of biweekly columns adds up to around 150 columns. At about 800 to 1,000 words each, that’s enough to fill two or three books. Here are some parting insights from my 25 years in the sales business, six of them writing Savvy Selling, which I’d like to share with you.
1. Life is short. Make yours count. Reach for the low-hanging fruit first. Identify those people you can present or complete the sale to, or help today. Call them right away. Then work on your long-term sales prospects.
2. Be real. To start, find out who you are so you can be real to yourself. What are you good at? What do you like? What’s important to you? For instance, I found that my favorite part of public speaking was giving workshops and helping individuals, not giving keynotes from the podium, where I was expected to pontificate on three points and worry about my arm gestures.
Next, be real with others and encourage them to be real with you. I’ve found that by doing so with my customers, they feel safe enough to share who they really are with me. Only then can they tell me what’s truly important to them, which allows me to sell them the right solutions in the right way at the right time. As a result, everyone wins and selling is easy.
3. Be bold. Create big doorways of opportunity and then walk through them. BusinessWeek created this column for me after I sent a letter to the site’s editor. They asked if they could print it, I said yes, and inquired if they wanted a sales columnist. They said yes—and we struck a deal that day.
A similar process led me to my podcast series. The president of an Internet company mentioned podcasts to me, so I asked BusinessWeek if I could record some for them, even though I had no idea what podcasts were. Four months later when I got the green light, I jumped in and booked Zig Ziglar, the famous master motivator, as my first guest a few weeks before his 80th birthday. Ziglar was a delight and I had a ball interviewing him and the 44 guests that followed.
4. Have fun. The old saying, “If Momma ain’t happy, ain’t nobody happy,” applies to sales, too. If the salesperson isn’t having fun, nobody’s having fun. Don’t be dry; sell in a way that brings a smile to your customers and makes them look forward to seeing you.
My office is filled with funny things to help me lighten up. I have a Rodney Dangerfield doll that says in Rodney’s voice, “I don’t get no respect,” and a sign my kids bought me that reads, “Beware of Attack Salesman.” I collect humorous mugs and silly books, too.
5. Balance your family and work. Six years ago, I asked BusinessWeek if I could write a column about the death of my son, Mark, and the lessons I’ve learned from that terrible experience. That column (BusinessWeek.com, 7/19/02) generated over 100 e-mails from around the world. Every following year in late July, I wrote a column about balancing family, work, and life. Your letters in response have been a great source of healing and encouragement to me. This is an example of the payoff I’ve received from being real and bold.
6. Love all, always. I know this is a sales column, but it applies to our customers, employees, and families, too. Life really is short; sometimes it ends abruptly. Everyone you meet is fighting a tougher battle than you know, so be gentle. The best we can hope for is to live a full, happy life and leave behind a handful of people who love and respect us.
As the classic breakup line goes, “It’s not you, it’s me.” I am bidding you farewell so I can spend my time boldly tackling whatever it is I’m supposed to do next. Please feel free to keep in touch—and happy selling!
Designing the ‘Care’ into Health Care
November 2nd, 2007 | Posted by innovIn the current political debate over America’s health-care crisis, candidates’ solutions appear to be divided along party lines. Democrats want to offer universal health care (but to varying degrees and in slightly different ways) while Republicans, if they have commented on the issue yet, promote a free-market approach. The debate boils down to varying levels of commitment to universal coverage and ideas about who’s going to pay for it.
To a designer’s eye, efficiently providing for a basic need is indeed the fundamental issue. But it should be possible to go beyond rudimentary solutions to achieve the overall objective of a healthy population by also addressing an essential question: What does the individual want and need from the experience of health care?
The fact is, even among those covered by insurance, no one is happy with the American health-care experience today. It is an expensive, complex system to which people resort only when a problem has grown threatening. Focusing on improving the user experience could inspire people to tap into the system more regularly to support healthful choices that could help stave off more serious illnesses. Innovations are called for that are relevant to people’s needs and encourage compliance, improve communication between doctor and patient, and help people help themselves be healthy. The candidates today have an opportunity to put the “care” back into health care.
Of course, while wellness is a desirable goal, a health-care redesign isn’t only about getting everyone to take care of themselves before and as they get sick. It is also about the bottom line. Workers are expensive. And as journalist Richard Seven noted in The Seattle Times in 2006, “Unhealthy workers are the most expensive of all. In any given year, 10% of them account for 70% of the health-care costs. Many of the expensive chronic diseases such as some types of diabetes and cancer are lifestyle-related, meaning somewhat preventable.” Seven reported that Caterpillar (CAT) projected its wellness program may save about $700 million on health costs by 2015 and that Motorola (MOT) reported in 2003 that it was saving $4 in health-care costs for every $1 it spent on wellness.
Ziba Design’s research, conducted for a number of medical and pharmaceutical companies, indicates that consumers want to be empowered to make choices that enable them to live a long, healthy, happy life. The health-care system has evolved from an “Age of Entitlement” (from the 1930s to the 1970s, when employee benefits proliferated and group health care gained popularity), through a have and have-not “Age of Privilege” that existed from the 1970s to 2000, when health costs rose, forcing many to go without health insurance, and cheaper, managed-care plans replaced employer-sponsored group plans.
Today, we live in an “Age of Responsibility,” when consumer-directed health plans are gaining momentum to counteract rising health costs. Consumers have the opportunity to exert more control over spending their health-care dollars, and to judge their health-care outcomes. Girding this trend is Web 2.0, which promises to empower consumers with healthy lifestyle information and better communication with health-care providers.
What lies ahead is an opportunity to design a health-care experience that reflects our nation’s desire to help itself be healthy. Let’s call it the “Age of Empowerment,” when we innovate to create healthful experiences that can save money, support better clinical outcomes, and improve patient quality of life.
Design thinking can lead us there. Institutions like the IIT Institute of Design in Chicago have begun researching design-based solutions to the health-care problem. Their Rethinking Health initiative aimed at creating human-centered, systemic solutions was recently awarded a generous grant by Robert C. Pew, chairman of the boards of both Steelcase (SCS) and the Institute of Design, that will allow large-scale systems design, economics and design, and user-centered design research.
Here are some examples of what health-care experience innovation looks like:
Empowerment through self-care: Home-based dialysis is an example of self-care that provides a win-win solution for everyone. A recent report published in the medical journal Peritoneal Dialysis International recommends home-based services as the treatment of choice. The report, written by Fresenius Medical Care, the largest provider of in-center dialysis care in the country, states that “patient independence, lower mortality, reduced hospitalizations, higher overall satisfaction by patients, and lower costs are clear benefits to the [home] dialysis provider. Providing patients with the option to choose is clearly the right path, and exactly what we would want as patients.”
Glucose monitoring for diabetics is a good example of self-care, with Roche (ROG), Lifescan, and Abbott (ABT) leading the way selling blood test strips for personal use. Experience innovation in the design of easy-to-use glucose monitors and supporting online services have replaced the days of cumbersome, multistep test kits that provided limited information. Today, smart monitors provide the patient with information related to diet, medications, and other factors that enable them to better manage their glucose levels and are connected to caregivers who can support a patient’s care.
Empowerment through service innovation: Company health programs can support employee wellness. Pitney Bowes (PBI) set up health clinics at its largest sites, with appointment hours available before 8 a.m. and after 5 p.m., made healthy changes in the cafeteria, encouraged workers to take the stairs rather than elevators, and to wash their hands regularly. They have also given employees pedometers to reach a goal of 30 minutes of exercise per day. Joseph Straw at The New Haven Register explained the additional boost to the bottom line: “The return comes in increased productivity, fewer sick days, and reduced costs in worker’s compensation and retiree health care, all of which they said should be viewed as part of health-care costs.”
Retail health clinics like MinuteClinic offer patients quicker, more affordable, and more convenient diagnosis and treatment of common illnesses. This provides a simple, cheaper solution for many patients who tend to avoid the doctor’s office until they are really sick because it costs too much and takes too much time. Clinics are popping up everywhere, with over 200 clinics in more than 20 states.
Empowerment through Internet technologies: Online tools allow people to manage their own health records and maintain a comprehensive history. For example, Microsoft’s (MSFT) HealthVault will offer free, secure personal health records that, once given permission by a patient, will be made accessible to doctors, clinics, and hospitals. Reliefinsite.com allows doctors, clinics, and patients to work collaboratively to map, monitor, and analyze pain.
Social networking and online community-building tools have the potential to create healthy communities. Imagine a help desk that would extend health care beyond limited office hours; the use of e-mail, chat, or Twitter for drug regimen updates; RFID for monitoring and medical device identification; visualization tools for patients to chart sources and severity of pains, symptoms, and drug intake, to show doctors during later visits. The sky’s the limit.
User-centric experience innovations need not be relegated to businesses using design to establish a loyal bond with their customers. Applying time-tested design methods to a national institution like health care can help ensure that our citizens not only have affordable care, but that the quality of the care actually empowers them to live the lives they desire. Nothing much: just a long, happy, healthy life.
Ziba Creative Directors Eric Park and Jeremy Kaye contributed to this article.
November 2nd, 2007 | Posted by innovThe U.S. jobs juggernaut continued to defy expectations for any marked slowdown in the October employment report released on Nov. 2, placing itself firmly in the array of economic indicators that are failing to confirm any broad slowing in the economy. There was some weakness in the factory figures this time around, and the wage figures showed some reprieve. But the construction sector outperformed expectations yet again, as did payrolls, with firmness in the workweek and steady growth in overall hours worked.
Nonfarm payrolls surged 166,000 in October, which was nearly double economists’ median estimate of 85,000. September’s increase was revised down slightly, to 96,000, from 110,000 previously, while August’s 89,000 was revised up to 93,000 for a net -10,000 revision. The unemployment rate was steady at 4.7%. Average hourly earnings rose 0.2%, following a 0.3% gain in September (revised from 0.4%). The average workweek was flat at 33.8.
Manufacturing shed an additional 21,000 jobs. Construction employment fell only 5,000. The service sector added 190,000 jobs, with government jobs up 36,000, while financial firms added 2,000 jobs and the retail sector lost 22,000.
The data are consistent with a 0.4% October personal income gain that will leave disposable income poised for 5.4% fourth-quarter growth, following the 6.1% clip seen in the third-quarter gross domestic product report released on Oct. 31. We now project a flat October industrial production figure that is consistent with a 1.0% first-quarter growth clip, vs. the 4.0% pace in the third quarter and 3.6% rate in the second.
The 0.1% rise in the October hours-worked index leaves this aggregate poised for a 1.2% clip in the fourth quarter that repeats the rate of the third. The trajectory for hours worked remains strong relative to our assumed fourth-quarter slowing in GDP growth to a 2.0% rate from the roughly 4% rate of the past two quarters.
The tiny 5,000 drop in construction employment in October, and 0.4% surge in construction hours worked, is surprising, and has prompted an upward revision in our October construction spending forecast to 0.1%, following the surprising 0.3% gain already reported in August.
In total, the October jobs report has extended the ongoing dichotomy between actual available data, which show a resilient U.S. economy outside the housing sector, and widespread expectations that the broader economy is doomed to experience a sizable hit from credit-market turmoil.
All of which raises the question: What if Wall Street throws a panic, and nobody shows up? Recent data have largely supported the view that, outside of housing, the broader economy remains highly resistant to credit-market turmoil, with a pattern similar to the response to the Long Term Capital Management crisis of 1998, and the stock market crash of 1987. As it stands, the available data are consistent with the Fed’s relatively hawkish statement following the Oct. 31 Federal Open Market Committee meeting, which suggests that if we don’t get any additional evidence of weakness beyond what is currently expected, the Fed is unlikely to ease again.
Although equities have proven remarkably strong through this period of credit market turmoil, market movement may now reflect that Wall Street is “on its own” to absorb the price hit from revalued subprime loans. Declining stock prices and the dollar, and a flight to quality that is driving prices of Treasury securities higher, may well reflect expected weakness in financial portfolios rather than an expected marked slowing in aggregate economic growth. The market will need to remain open to the possibility that the hit to the ex-housing economy from credit-market turmoil may prove much smaller than widely expected, as with many prior periods of financial market crisis.
Small Business Caught Betwixt and Between on Tax Overhaul
November 1st, 2007 | Posted by taxThe ink is barely dry on what’s being billed as the most sweeping change in the tax code since the Reagan Revolution two decades ago, and small businesses are already caught in the crossfire.
The question is, are they victim, benefactor, or merely cannon fodder in a political debate that is all but destined to spill over into the presidential election? Since House Ways and Means Committee Chairman Charles Rangel, D-N.Y., introduced the Tax Reduction and Reform Act of 2007 on Oct. 25, both sides in the debate have repeatedly invoked small businesses to argue for or against the measure.
Obviously, they both can’t be right … or can they? Based on a preliminary reading of the measure, small businesses will be hurt by some provisions and helped by others. It all depends on how firms are structured and whether they rely on certain tax breaks that face repeal.
So far, only one prominent small business group, the Small Business & Entrepreneurship (SBE) Council, has taken a position on the bill. It fired off a statement saying the measure would be a “punishing blow” for small companies. “With all due respect, the bill takes aim at the entrepreneurial sector, and will vastly hurt their job-creating, innovative, and competitive capacity in the global economy,” SBE Council President & Chief Executive Karen Kerrigan asserted.
The organization’s chief economist Raymond J. Keating even went so far as to say the proposal smacked of “class warfare.” Indeed, the notion of class warfare has been the rallying cry of hard-right conservatives who don’t like the income redistribution aspects of the legislation. For his part, Rangel has made no secret of the fact that he is attempting to address imbalances favoring the wealthy that were written into the tax code by the Reagan administration in 1986.
In the years since then, there is no denying the rich have gotten substantially richer. The rest of the nation has seen incomes stagnate or rise only modestly. During the current expansion (since 2001), however, the gulf has widened even more significantly, according to the Center on Budget and Policy Priorities, a nonpartisan economic think tank based in Washington, D.C.
Pre-tax income for the top 1 percent of the nation’s households (earning $350,000 a year or more) increased from 17.8 percent in 2004 to 19.4 percent in 2005, marking the highest concentration of wealth since 1929. And the very rich, who make up the top 0.1 percent of households, saw their incomes rise even more, according to the center. “With income concentration returning to its highest level since before the Great Depression, it is difficult to argue that these data depict an insignificant, short-term blip,” the center noted.
Rangel attempts to address the disparity by imposing a 4 percent income tax surcharge on households with $200,000 a year or more in income, or 4.6 percent for those earning over $500,000 ($250,000 for singles). Rangel also would raise the capital gains taxes to 19.6 percent from the current 15 percent rate. Opponents claim that the surcharge would hurt sole proprietors, S corporations, and partnerships because they must treat business income as personal income for tax purposes.
But would it really?
The Tax Foundation, a nonprofit organization devoted to studying the tax code, claims 75 percent of the taxpayers in the highest income tax bracket are small business owners or farmers. But according to the Small Business Administration’s Office of Advocacy, home-based sole proprietors only averaged $62,523 in gross income in 2002 and $22,569 in net income. Sole proprietors with offices or store fronts grossed $178,194 and netted $38,243 after taxes. They not only avoid the surcharge, they would benefit from Rangel’s plan to abolish the Alternative Minimum Tax, which will start hammering the middle class ($75,000 or more in income) this year.
Sole proprietors who have higher receipts could simply incorporate as C corporations. The Rangel measure lowers the tax rate on them to 30.5 percent from 35 percent. The move will save companies $364 billion over the next 10 years. On the other hand, the Rangel bill would raise about $241 billion in corporate taxes by repealing a series of arcane loopholes, such as a deduction for domestic production activities, rules that allow the allocation of interest to foreign subsidiaries, and deferrals for expenses and taxes of repatriated foreign income. Those offsets will affect about 4 percent of small businesses, according to the U.S. Treasury Department.
In another plus for small businesses, the bill would make permanent the Section 179 deduction for plant and equipment expenditures up to $125,000, phasing out at $500,000. Then again, small businesses might be hit by the bill’s repeal of the LIFO (Last In, First Out) inventory accounting method, which would raise about $107 billion over 10 years. Many businesses, however, now use, or will likely switch to, “just in time” inventory management to dodge that cost.
One of the biggest bites out of corporate America will come from the repeal of rules governing taxation of so-called “carried interest” by hedge fund managers. It will raise $25.66 billion over 10 years. Critics argue that it could affect the availability of venture capital for small firms. That may be so, but there is no direct evidence at the moment that venture capital will become less available.
In the end, the full impact, plus or minus, on small businesses has yet to be fully determined. But that hasn’t stopped a full-scale assault on the measure by the Bush administration and other Republicans. The good news is the tax bill is unlikely to pass until after the presidential election next year. That will give small business advocates plenty of time to fully analyze the measure.
But there is one thing the Rangel bill clearly doesn’t do — simplify the tax code. That has long been a top priority for small firms. Until it happens, tax season will still be a punishing ordeal for the nation’s entrepreneurs.
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