Growth Engines

New York, like any city, needs entrepreneurship to survive. As old businesses become obsolete, new start-ups must replace them, or employment will wither. If a particular industry becomes hugely successful and brings vast wealth to a city, real-estate costs can soar, allowing the local government to overtax and overregulate complacently—and driving out the scrappy entrepreneurs who will build the economy of the future.

That’s exactly what happened in Detroit. If the current crop of mayoral candidates don’t want it to happen in New York, too, they must understand that cumbersome regulations and high taxes are discouraging the entrepreneurs the city needs. In a recent Zogby poll of New Yorkers carried out for the Manhattan Institute, 65 percent of respondents thought that the city administration wasn’t doing enough to encourage entrepreneurs and small businesses to increase their presence and hiring, and 67 percent considered “the current environment for the growth and development of small business in New York City” poor or fair. Similarly, a 2013 survey performed by thumbtack.com and the Kauffman Foundation gave New York a grade of D for the ease of starting a new business.

Entrepreneurship is the wellspring of long-term economic success. So these barriers to starting a business are a major problem facing the next mayor.

Small businesses are crucial to economic growth. The legendary economist Joseph Schumpeter, an apostle of entrepreneurship, contended that small start-ups generated the disruption that led to progress, but he had few statistics to back him up. Over the last 25 years, new data have proved him right. Cities—or even neighborhoods—with an abundance of small businesses also boast robust employment gains.

The Census Bureau provides some coarse measures of entrepreneurship, such as an area’s average establishment size and the fraction of an area’s employment that’s in recent start-ups. A place with small companies and a lot of jobs in new firms is probably more entrepreneurial than one ruled by a few giants. The very crudeness of these measures makes the strength of their connection with economic health more remarkable. The one-fifth of American counties with the smallest establishments in 1977 saw employment grow three times faster by 2007 than the one-fifth of counties with the largest establishments. Controlling for a wide range of other factors, including education levels and temperature, Bill Kerr, Sari Pekkala Kerr, and I have found that a 20 percent increase in a metropolitan area’s average establishment size in 1982 correlated with 12 percent less job growth over the next two decades.

Fifty years ago, the economist Benjamin Chinitz argued that Gotham benefited from a culture of entrepreneurship created by its dominant twentieth-century industry, garment production, in which anyone could get started with a good idea and a couple of sewing machines. (My own view is that New York’s entrepreneurial culture arose earlier, thanks to its port, which gave rise to many small start-ups, including those clothing manufacturers and also the financial firms that dominate the city today.) Chinitz contrasted bustling New York with lethargic Pittsburgh, which was ruled by steel production, an industry with massive barriers to entry. During the 1950s, competing with U.S. Steel was like competing with the New York Yankees.

The two Kerrs and I have found support for Chinitz’s theory that a culture of entrepreneurship can perpetuate itself in a city. Places that were close to coal or steel mines a century ago—Pittsburgh and Birmingham, Alabama, for example—not only had larger firms then; they have larger firms today. As a result, those cities have suffered low employment growth over the last 30 years, even outside the Rust Belt, and even in industries unrelated to mining. The culture of entrepreneurship may be transmitted through families. One well-cited study has found that self-employed parents are twice as likely as company men to have self-employed children.

Though New York’s industrial past shows the value of entrepreneurship, New York’s present is dominated by relatively large firms. The average establishment in Manhattan is 25 percent larger than in the nation as a whole. Further, the city’s most important industrial cluster is finance and insurance, which is responsible for 39 percent of the payroll in New York County, and finance is famously led by firms that the federal government considers “too big to fail.”

True, New York’s small-business problem hasn’t gotten worse over the last decade or so. Between 1998 and 2010, the size of the average Manhattan firm rose only slightly. The number of small companies has fallen dramatically in wholesale trade, transportation, and especially manufacturing—the last 15 years have witnessed the final demise of clothes-making in New York—but has risen enough in other areas, such as arts and entertainment and restaurants, to offset that drop.

In New York’s financial sector, however, the Goliaths seem to be throttling the Davids. The average Manhattan financial establishment had 36 employees in 2010, up from 33 in 1998. Also in Manhattan, the number of finance or insurance firms with fewer than ten employees fell from 6,734 to 5,201.

Given the enormous barriers that confront small businesses in New York, it’s amazing that the city has as many as it does. For years, the World Bank has measured the ease of starting a new business in sites around the globe. New Zealand leads the list: it requires the budding entrepreneur to undertake a single procedure that consumes just a day and costs only 0.4 percent of an average person’s annual income. At the bottom of the list is Haiti, where starting a new business requires 12 procedures, 105 days, and almost three times an average person’s annual income.

The United States as a whole ranks fairly well at 13th place, but things are considerably harder in New York City. If you want, say, to open a goods-producing facility in the Big Apple, you’ll need at least ten permits, including a certificate of occupancy and a fire department–issued Place of Assembly Permit. Your drivers will need special commercial driver’s licenses from the city; your van will need a city parking card. Any modifications that you make to your building will need a barrage of permits, and expect an even bigger barrage if your business is located in one of the city’s many historic districts. Those are just the local rules, of course; you’ll also have to deal with the federal regulations that burden small businesses. Plan to file a 1099 form with the IRS for every vendor you pay more than $600, for example. If your company has 50 employees or more, you’ll eventually have to comply with Obamacare, which mandates that you provide them with health insurance. And so on.

Another obstacle to business formation in New York City is city and state corporate taxes. The state’s 8.63 percent corporate tax is slightly lower than what’s charged in some of its neighbors, such as New Jersey and Pennsylvania, but substantially higher than in many other states. And New York City, unlike most American cities, adds its own corporate income-tax rate of 8.85 percent to the state’s levy, meaning that businesses in Gotham can end up paying a significantly bigger chunk of their profits than businesses elsewhere do (see “Overburdened”).

The financial firms that thrive in Manhattan may find ways to credit their income to other locations, but a small business with its sole office in the city doesn’t have that luxury. During the early days, it’s true, some start-ups earn no profits, which means that the corporate tax doesn’t affect them (though they’re still hurt by the city’s high personal income tax). But as soon as they become profitable—and start generating the jobs that New York needs—they’ll have a strong incentive to move to a place that taxes their profits less.

That 2013 survey that gave New York a grade of D for the ease of starting a new business actually represented an improvement from the city’s F the previous year. The improvement was most noticeable in the areas of regulation and licensing, which rose from a D-plus and a C-minus to a B-minus in both categories. The upgrade probably has to do with NYC Business Express, a city service introduced by Mayor Michael Bloomberg that does an admirable job of outlining the steps that businesses must take to get up and running.

But that’s only a start. Real regulatory reform would do wonders to foster small-business growth in New York. The mayoral candidates should commit to a system in which just one business-permitting authority—or, at most, two—imposes the rules. Such a system would include a one-stop shop for opening a new business, and that bureau would commit itself to speed. When the U.S. Army base at Fort Devens closed in Massachusetts, Governor William Weld and others worried about the economic consequences, and the legislature created a one-stop licensing bureau that decides in no more than 75 days whether new projects in the area may proceed. New York can surely do better than that. Why not guarantee a decision in 30 days—or even seven?

And the rules themselves should be reevaluated. Since 1993, federal regulations proposed by the executive branch have had to be subjected to cost-benefit analysis, a process overseen by the Office of Information and Regulatory Affairs. More recently, the office has been applying cost-benefit analysis to existing rules and attempting to overturn those whose costs exceed their benefits. The next mayor should follow the feds’ example, forming a special office of regulatory affairs charged with vetting new rules and examining old ones. The city council should subject itself to the office’s authority—Congress does not—and pass no new laws imposing regulations the costs of which exceed their benefits. Of course, the city shouldn’t simply go unregulated: fire risks are real, to name an obvious example, and businesses that ignore those risks shouldn’t be allowed to endanger their neighbors. But that doesn’t mean that every regulation is a good one. If the reform was done properly, New York could become a model for smart national deregulation, atoning for its decades of misrule.

Reducing the city’s onerous corporate taxes is harder than fixing the regulatory burden, since providing public services in an old, vast city will always be expensive. Mayoral candidates shouldn’t say that they’ll cut city expenditures dramatically by eliminating “waste and abuse”; the city has had competent management for far too long for that promise to be credible. Reducing corporate-tax rates, at least for smaller businesses, will require either politically painful spending cuts or increases in other tax rates.

But which? Economists typically say that a locality shouldn’t focus its taxes on mobile targets, such as entrepreneurs, since the taxation encourages them to move elsewhere. It makes more sense to focus on things that can’t move, such as land, which is perhaps why most localities in the United States draw their local revenues heavily from property taxes.

New York has historically been less willing to tax real property. But recently, it has been moving in the right direction. In 2006, only 28 percent of the city’s own source revenue (that is, excluding transfers from the state and federal governments) came from property taxes; by 2012, that figure had risen to 38 percent. The problem is that New York didn’t reduce the corporate income tax correspondingly. It should do more to shift taxes from small businesses to landowners. It’s even possible to base property taxes more on the value of land than on the value of the structures built atop that land, thus preventing tax hikes from deterring the new construction that the city needs.

The New York economy has done well during the Bloomberg era. Despite the recession that followed the 9/11 terrorist attacks and the graver economic meltdown of 2008, overall real earnings in Manhattan rose 18 percent between 1998 and 2010, and earnings per employee rose 17 percent. (Across the country as a whole, they rose 12 percent and 8 percent, respectively.) But the city’s apparent health can itself become a danger, since the next mayor may not see much need to limit spending growth or cut back regulations. Indeed, the city council has just passed a bill requiring firms with more than 15 workers to grant at least five days of paid sick leave. The law seems humane, but it’s just one more regulation that will make operating a small business in New York more expensive.

The city needs to recognize that an entrepreneurial ecosystem is fragile. New York’s future success isn’t a sure thing—but the best way to foster it is to make life easier for entrepreneurs, the key to urban vitality.