Start ups and tax rates

The British government has raised capital gains tax, as they had signalled they would; in response, my X feed has been inundated by people complaining that the move will discourage entrepreneurship.

Two things here: first, it seems wildly unlikely to me that many aspiring entrepreneurs will refuse to pursue their passion or work on a promising idea because the tax on capital gains has gone up. Like… I don’t think that Jeff Bezos or Mark Zuckerberg or Page and Brin pulled out an Excel and plugged in a variable for their personal CGT before committing to founding their companies.

Now you might argue, not everyone aspires to build a trillion-dollar business. Some just want to open a little coffee shop, and there an increase in CGT might just about tip the balance between doing that, or working as an employee for a company. Sure; but is that a bad thing? If the financial viability of a business is so low that an increase in CGT makes it not worthwhile, then it’s probably better that this business is not founded in the first place? If its would-be founder can earn more as an employee, this suggests their labour has a higher rate of return in that capacity.

Which brings me to the second point: there is a collective obsession with start-ups. Supporting entrepreneurship seems to be the one thing left- and right-wing governments can agree on. Everyone wants more start ups.

But why?? Large companies are twice as productive as small ones:

British entrepreneurs point to the thriving US VC ecosystem and urge people in Europe to start more companies, but what this overlooks is that the US owes its success not to the myriads of small companies that are founded each year, but to a) the ability of those companies to grow, and b) the existence of a huge number of enormous established companies. I think most Europeans don’t realise just how many large companies there are in the US: there are somewhere around 50 companies that are worth more than the UK’s largest company by market cap — and yes, many of them were not start ups too long ago, but many have been around for hundreds of years.

Indeed, this narrative that the problem in Europe is the dearth of entrepreneurs is gathering steam — even as objective and critical a thinker as Scott Alexander links the two:

36: Elsewhere in “Italy sucks” news - did you know Italy’s tax code effectively bans startups? Companies are taxed before making any money, based on how many assets they have. If they have lots of assets but aren’t making money (eg because they’re still doing research / in stealth) then tax officials get confused and hostile and run increasingly punitive audits. Related: size of the European tech sector.

Now, first, I am not sure I believe this chart. It suggests that the market cap of tech companies in Europe is less than 1 trillion; but Europe’s top 2 tech companies — ASML and Siemens — are worth around 0.5 trillion by themselves. Second, this shows the US tech market cap is about 8 trillion — but that’s basically just Apple, Alphabet, and Amazon. And third, company formation per capita in the US seems to be ~23% higher than in the UK. Higher, to be sure; but is the compounding effect of this really what drives the difference in market caps between the two countries?

So, again: the problem in Europe is not that we don’t found enough companies. It’s that we’re terrible at scaling them. The existence of these large companies has several effects. They provide a talent pool of people with deep expertise and managerial know-how (which is often under-appreciated in Europe; for instance: most marketeers I’ve met in tech companies in Europe don’t actually have marketing training. They are more like project managers, who happen to pick up a few marketing concepts here and there. But ask them how they’d measure brand equity, and many would struggle to answer. The advice people like Tom above give — ‘don’t work for McKinsey — start a company instead’ — is predicated on the assumption that raw intelligence and talent trump experience. I’d argue many young people would be better off learning managerial best practice at a well-run company, and then using that to start something of their own.)

Large companies also have deep pockets, which they use to invest in R&D. They have the luxury to invest in training & developing their people, in a way that start-ups and SMEs don’t (Coca-Cola can afford to have its people attend seminars, L&D programmes, etc; a start-up whose people are working round the clock, not so much; and yes, learning on the job is very much a thing, but again, large companies have learnt how to teach people on-the-job over decades if not centuries of doing it). They compete for talent, hence pushing wages up (which can also encourage entrepreneurship: those people can save enough to start a business, or support a spouse who wants to do so). And these are all the rather ineffable elements, without even going into the much more tangible productivity advantages large corporates enjoy (economies of scale, distribution networks, etc).

Governments and societies that encourage people to found SMEs, but which then discourage scale (because they view large companies with suspicion, or because they consider them less glamorous, or antiquated) will keep experiencing stagnation.