Impact Of Recent Accounting And Financial Scandals On Regulatory Bodies

Impact of Recent Accounting and Financial Scandals on Regulatory Bodies

Abstract

This essay has concentrated on the broad subject areas of the Impact of Recent Accounting and Financial Scandals on Regulatory Bodies and reducing regulatory burden and undue litigationвЂ"because these are the topics that innovative entrepreneurs tell us are the most important to them and what they believe will be most important to innovative entrepreneurs in the future. At the same time, however, other policies clearly will have an important impact on innovative entrepreneurship and the U.S. economy in the years ahead.

Two prominent examples are how federal policymakers deal with future budget deficits looming because of entitlement programs for the soon-to-be-retiring baby-boom generation, and whether the United States and other countries will backslide or move forward toward further trade liberalization in an environment where increasing numbers of citizens are nervous or skeptical about the value of globalization. Dealing with the long-term budget deficit is important, if not essential, in order to maintain a low-interest rate environment (which makes it easier to finance new ventures) and to avoid financial crises. Open trade is vital because it ensures that all firms (including entrepreneurs) and consumers have access to the least expensive inputs and goods and services, while being able to sell into other markets.

There are two other policy subjects, perhaps closer to entrepreneurs’ daily experiences, which also could have an important impact on future entrepreneurial patterns: taxes and access to capital. Yet for reasons elaborated in the next sections, the impact of policies in these arenas is more complicated than may first appear, and each will benefit from further research.

Tax Policy and Entrepreneurship

One of the central tenets of those who study economic behavior is that incentives matter. Simply put, people are more likely to do more of something if they are rewarded for it, and less of it to the degree that they are penalized for doing it.

An obvious question, then, is how tax policy influences entrepreneurial activity. At first blush, one would think that as marginal income tax rates increase on entrepreneurial incomeвЂ"whether realized as personal income to the entrepreneur or as income to a corporationвЂ"the after-tax rewards from engaging in entrepreneurial activity decline, and therefore so should the activity itself. But the reality may be very different, yielding some not-so-obvious insights.

For example, one early (and now classic) article on this subject suggested that while higher marginal income tax rates may discourage economic activity in general, they may encourage risk-taking of the kind displayed by entrepreneurs.1 The reasoning is that as tax rates increase, the government bears more of the risk from entrepreneurial endeavors. With more risk-sharing by another party, the entrepreneur’s own “risk premium” will be lower, encouraging him (or her) to take more risk.

A much more recent analysis suggests that it is the shape of the tax schedule that is more important for entrepreneurs than the actual level of the marginal tax rate. In particular, as the tax schedule grows steeperвЂ"or more progressiveвЂ"then the reward for entrepreneurial activity, at the margin, declines.2 Other analyses find that the level of the marginal tax rate does in fact make a difference, but in a counter-intuitive way: higher marginal tax rates encourage self-employment or entrepreneurship.3 One possible reason is that small business owners can more easily underreport their income, or find ways to deduct some personal expenses, than employees earning wages and salaries.

A further complication is the interaction of personal and corporate income tax rates with incentives to engage in entrepreneurial activity. Generally, individuals launch their enterprises as non-corporate endeavors, and have tax incentives to do so as long as the personal tax rate exceeds the corporate rate. If so, and if they experience losses in the beginning (as many, if not most, entrepreneurs do), then the tax savings are greater if the enterprise is not incorporated (so that the losses can offset the entrepreneur’s personal income). When the enterprise begins to be profitable, if the corporate rate is lower than the personal rate, entrepreneurs will want to switch to the corporate form to take advantage of lower taxes (and also because the corporate form is more suitable for an enterprise with employees). Thus, somewhat paradoxically, as the personal income tax rate increases relative to the corporate tax rate, entrepreneurship may be encouraged. Conversely, cuts in the personal income tax rate relative to the corporate rate may discourage entrepreneurship.4

In sum, the relationship between taxation and entrepreneurial activity is more complicated than it may appear at first. More research in the future may simplify and better clarify this connection.

Regulation of Capital Markets and Corporate Governance

One of the reasons for America’s entrepreneurial success surely lies in its well-developed financial system. If they don’t have the wealth on their own to launch their enterprises (which most of them do), entrepreneurs with good ideas can and do borrow against their homes or on their credit cards to get started.5 A few begin with bank financing. Others, often (but not always) among the most promising of companies, are backed from the beginning by venture capital funds and increasingly “angel” investors or groups. Highly developed securities markets, in turn, have enabled third party investors to “liquefy” those investments with potentially large gains if the enterprises are “taken public.” To be sure, there are imperfections in this systemвЂ"pockets of discrimination by some lenders appear to remain, for example, and a common complaint among entrepreneurs is that they have difficulty finding capitalвЂ"but on the whole good business ideas in America seem to get funded, one way or another.6

Various government policies have facilitated the development of this many-layered system of entrepreneurial finance:

• The packaging of mortgages into securities that are now generally sold in the capital markets is an activity that was spurred by federal guarantees and government or quasi-government agencies (the housing finance agencies: Ginnie Mae, Fannie Mae, and