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Even the Best Startups Can’t Overcome Tax Rates in China and the US

MobiSights has written before about some of the disadvantages of the venture capital environment in China, and this post by Juliana Davies takes a deep dive into some of the taxation differences for small business between China and the United States. Juliana writes for an online business magazine that has ranked 2012’s best online MBA programs, and seeks to spread the word about business education in an objective way.

Small businesses represent 99.7% of all private-sector employers, provide great innovation and are the most potent force to revive America’s economy, which cannot grow at a healthy pace without them, says Jay .S. Fishman the chairman and the CEO of Travelers Companies in his op-ed in Bloomberg. The fact that clearly emanates from this statement is that it is important to bootstrap start ups to boost the economy. The recently released NYSE Euronext 2012 CEO Report however does not paint an optimistic picture. According to the report, 2/3 of U.S. small business owners say they may not add jobs in 2013, with some anticipating reductions in their workforce.

This downside can be attributed to current U.S policies –specifically in the areas of corporate taxes, licensing and bureaucratic snags and inconsistencies. An article published in Council on Foreign Relations says that the United States has the highest statutory corporate tax rate in the world–39.2% (including state and local) versus an OECD weighted average of 27.8 % (excluding the U.S.), and a G-7 average of 32.3% (excluding the U.S.)

Peter Schiff, writing for Business Insider, elucidates in his article “Not Even Communist China Taxes As Much As America” how this high rate of taxation puts American corporations at a noticeable disadvantage vis-à-vis companies in China, where the corporations are taxed at a rate of 25% and dividends at 10%. Studies have also shown that small businesses in United States face a host of federal taxes, which includes income taxes (individual and corporate), social security and Medicare employment taxes, excise taxes and unemployment compensation taxes.

Start up firms in U.S. also struggle to get permits to operate their businesses. The process is expensive and time consuming. A study titled “License to work- a national study of burdens from occupational licensing” released by the Institute for Justice documents the license requirements for 102 low- and moderate-income occupations across all 50 states and the state of Columbia. A recent article in Bloomberg quoted a 2008 Gallup survey that says in 1952, less than 5% of U.S workers required a state license, but by 2006 the figure went up to 29%.

Yet another hurdle facing the start-ups is the bureaucratic chokehold. It is challenging to find government programs and resources. When found, the complexity of paperwork and proliferation of forms makes the whole application process cumbersome and confusing. Startup America Reducing Barriers Final Report –SBA  suggests that timelines for decisions on government award programs and regulatory processes are too long for entrepreneurs. To add to this is the built-in uncertainty in federal legislative and regulatory processes, which results in many investors and entrepreneurs shying away from taking risks.

In China, too, businesses have to jump through bureaucratic hoops before they gain access to the market. There is a complicated registration–based system to get the license and approval to operate. This Doing Business Project report gives a detailed summary of the bureaucratic and legal hurdles faced by entrepreneurs in China. The government exercises considerable control by subjecting start-ups to a dozen inspections per year. Business experts believe that soft infrastructure in the country is still underdeveloped, which leads to inefficiencies. For instance, they say each province in China has a different licensing system.

The increase in the Internet’s economic and social importance has led to more political intervention and more regulations in China. In June 2010 the government published a white paper outlining its regulatory plans according to article published in The Economist. In May China said it had created a central agency to oversee the Internet.

Despite a challenging environment for new businesses, China is becoming one of the next hot markets for start-ups. Last year, 138 venture-backed companies in China went public, raising about $21 billion, according to VentureSource. There is a great deal of entrepreneurial activity among homegrown Internet companies, fueled by the success of companies like Tencent, Taobao, and Sina Weibo, which adopted a more pragmatic approach of adapting western models to meet the local needs. Regulations are tough and costly to comply with, but nobody seems to complain; as Mr. Lee of Innovation Works says:  “People take the government as a given.”

Written by Juliana Davis

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