The Business World: Cut the red tape and let small firms breathe

Expect better investment allowances for small firms, further tax incentives for venture capital investment - including something for high- technology companies - and changes in capital gains tax
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The Independent Online
IF YOU are running a small business, or thinking of starting one, which of the following three things would you want of the Chancellor in next week's Budget? One: some new tax incentive for small businesses? Two: a package to boost enterprise and productivity? Or three: simply fewer government regulations?

Yes, it would be nice to have all three, but my guess would be that if business people had to choose only one, most would plump for the third. They don't want government to do more. They want it to do less.

There is the dilemma for Gordon Brown, and one of the most interesting things to look at next Tuesday will be how he tries to resolve it. For everything he has said about the forthcoming Budget, his instincts to try to find ways of encouraging enterprise will be translated into tax incentives and a more general business-boosting package. But if you look in practice at what has happened in the past few weeks, small businesses have been damaged by government action.

The introduction of self assessment has put a sharp cash squeeze on large numbers of sole traders, an effect made worse because the Inland Revenue miscalculated many of the tax demands. In addition, even small businesses have had additional admin burdens loaded on to them by European Union directives on work hours, while the minimum wage and the working families tax credit have put still greater loads on the management team. In short, what the government says is precisely the opposite to what it does.

There is a particular problem here for small businesses. Large ones hire people to cope with the additional administrative work. This costs money, but large companies can always shed some workers or close a factory to offset the cost. A small business usually cannot afford to do so and a sole trader cannot do anything at all, except try to reallocate their time away from the job and towards doing the admin instead.

The Government's defence would be that these costs are still lower than those of other EU countries. That is a fair point, but then the rate of business start-ups is lower there than it is here. If you exclude farmers the proportion of self-employed is lower too. The key comparison is not with Europe but with the US, where there is a higher business start-up rate.

Is the admin burden on US business, particularly small business, lower than it is on UK ones? Well, no. It is almost certainly higher. In the Global Competitiveness Survey, the UK did well in terms of the time that business people had to spend with bureaucrats: only the Scandinavian countries ranked better. The US was in the middle and among the big European countries, France and particularly Italy ranked badly.

But Italy has vibrant small businesses, and in much of Scandinavia they are worried about the lack of emerging businesses. So anyone trying to argue that excessive bureaucracy is the main thing holding back business start-ups in Britain has a tough case to argue. It is very difficult to get any hard evidence, but my guess would be that the UK bureaucratic burden, while worse than it was five years ago, is still acceptable by international standards.

So what is to be done? We should not sneer at the measures Gordon Brown will announce on Tuesday. Expect better investment allowances for small firms, further tax incentives for venture capital investment, including something for high-technology companies, and changes in capital gains tax to encourage asset holders who retain those assets for a number of years.

These changes should be helpful but it would be naive to expect anything dramatic to occur. The incentives for Venture Capital Trusts and for the Enterprise Investment Scheme are pretty big already. In so far as there is a financing gap for small start-ups, the problem is not lack of tax incentives but other barriers, which have more to do with culture and attitude than anything that can be tackled by a tax break.

For a start the number of rich people wanting to risk their capital by backing a new venture is quite small. Next, the mechanism linking would- be investors with would-be entrepreneurs is haphazard. Once you get above about pounds 250,000 the specialist venture capital companies start to become interested, but most start-ups need a lot less money than that. Below pounds 250,000 the costs of examining a project, making a decision, and monitoring the investment become too big relative to the rewards. So the only possible source of funds is from private individuals who want, as much as anything, the fun of backing a new business.

What is to be done? I have no magic wand, but I have a suggestion. It is that the Government should look at the regional differences in business start-up rates and try to identify why some regions - London and the South- east in particular - have high business start-up rates, while others - such as parts of Scotland - have relatively low ones. Is it a problem of supply or demand - is it possible to identify whether in some regions there is a relative shortage of capital to back ventures, or whether in those regions there is a shortage of people coming up with the projects? If the problem is money, it is relatively easy to fix. If it is a dearth of would-be entrepreneurs it is harder - but until you know the nature of the problem, you cannot begin to think how to fix it.

The good news is that much of the infrastructure for assisting new businesses is in place. The various development bodies have spent the past two decades trying to encourage inward investment, and been successful. But it is expensive to develop the incentives and companies are liable to up and leave. Now several of them are looking at refocusing their activities to try to boost local businesses. It is not easy and the impact on job creation, even when successful, is less dramatic. But within some of these organisations there is a growing view that this isthe only secure way forward if you want to regenerate an area. Seeing foreign companies shut a number of high-profile plants in the past couple of years has had a searing impact on development agencies' attitudes.

Does this mean more bureaucracy? Well, yes, in the sense that if a publicly funded agency is involved, there has to be proper controls as to the way taxpayers' money is spent. But development agencies can be enormously helpful in meeting small businesses' needs. They can start by setting up helplines to assist them to obey all those regulations.