This policy bulletin is extracted from Laws Affecting Small Business: Tax by Ian Hetherington & Eustace Davie, one of a series of booklets compiled by the FMF in 1999.The entire text can be read here.
The single biggest problem for most small businesses is lack of capital. Most entrepreneurs use their own savings or retrenchment packages to start up in businesses, sometimes supplemented by personal loans from family members and friends. They run into financial difficulties as soon as their businesses start to grow – having exhausted their personal savings, they find they have no access to loan capital to exploit growth opportunities.
Very few young entrepreneurs and, because of past apartheid laws, very few black entrepreneurs of any age, have mortgageable title deeds to property. Nor, at the beginning of their business ventures, have they been able to build up significant investment portfolios. Thus they are unable to put up the security required by banks and other lending institutions, which are in any case reluctant to lend to small firms. And there is as yet no significant venture capital market where entrepreneurs could obtain equity capital from outside, independent investors.
Small firm owners are therefore forced to rely on the cash flow generated from their own profits to finance their firms’ growth. Even when profits are good, cash flow is frequently squeezed by the need to carry more stocks and to invest in additional equipment to support greater sales volumes. The high inflation rates of recent years meant that more cash was required for new stock than was spent on the stock previously sold. The liquidity problems are compounded when, as is often the case, suppliers will sell only for cash and customers will buy only on credit. To complete this dismal scenario, the tax laws of the country require that a large proportion of any profits made, be paid to the state regardless of the devastation this may cause to the small firms’ cash position.
Tax is one of the greatest inhibitors of small business development. The high level of taxes, the enormous volume and complexity of the tax laws, and the administrative sophistication required to comply with these laws are daunting even for well-educated entrepreneurs. For those who through no fault of their own were educationally deprived, it would be easier to climb Mount Everest without oxygen than to understand and comply with all tax laws. There is an urgent need for simplification and preferably also for a reduction in tax rates.
That great and well-proven engine for wealth and job creation, the small firms’ sector, will continue to splutter and choke until there is serious tax reform. Economic growth will be curtailed, unemployment will continue to rise, and social instability will worsen.
AUTHORS: Ian Hetherington & Eustace Davie. This Policy Bulletin may be republished without prior consent but with acknowledgement to the authors. The views expressed in the article are the authors' and are not necessarily shared by the members of the Foundation.