The debate on the tax code for entrepreneurs in Finland is becoming more surreal by the day. The origins of the debate lie in the tax code working group set up by the Finnish Parliament. This group, headed by Martti Hetemäki, is to devise a new tax code for areas such as capital gains, options and carried interest for VC funds. The biggest verbal and rhetorical battle is waged around the double taxing of dividends in non-listed companies.
Just as with any tax code, the more transparent and simple the tax code to understand, the better it incentivizes people to invest in a risky and uncertain future. The tax code should make it easier to see how the future plays out for businesses, not make it more difficult. All the scenarios the working group is considering are rather complex and won’t help the state of entrepreneurship in the country.
Hetemäki Tax Code Variations
The Finance Ministry’s Permanent Under-Secretary and Chair of the taxation task force Martti Hetemäki has so far put forward several different options where every option would increase the taxation on the dividends of non-listed companies. One variation would just double the tax on dividends by taxing all the dividends under the capital gains tax of 30%. Another would let an active entrepreneur get dividends with a lesser tax burden up until €30,000. Of this, 35% would be taxed under the capital gains tax. A third variation would be modeled on the Belgian system, where the nominal corporate tax would be left at 26%, but after a deduction the real tax rate felt would be 22%.
Risk and Reward
Entrepreneurship is all about risk and its management: pulling it through against odds that are stacked against you like they are in no other area of life. It is hard enough to build a successful company if you have the environment optimized for building a company, as many would argue the startups in Silicon Valley have. Finland is not as lucky with regards to the inflow of talent, post-WWII industrial cluster creation or inbuilt culture for risk taking and dealing with failure.
Now, as if Hetemäki’s scenarios for tax code weren’t enough, Anni Sinnemäki, the head of the Finnish Green Party and Minister of Labour, further proposes that Finland should tighten the tax on dividends from private enterprises to fill the empty government coffers and should do it as soon as possible. Currently entrepreneurs can deduct up to 9% of their company’s net assets as dividends up to €90,000 without paying double tax on it (€90,000 only in the case the company has net assets of €1m or more). This amount is not tax free of course, but the company has already paid 26% corporate tax on that capital. Sinnemäki thinks Finnish entrepreneurs should pay double tax, which would amount to around 40% to 50% for every penny they make in return for taking massive risks to build companies in Finland that Finland’s prosperity will depend on once the Nokia effect fades out, which it will when the mobile phone giant moves all the rest of its operations from the country. Again, given our tax policy for companies and the talent they seek, Nokia would only be rational and act in their shareholders’ best interests to eventually move out. It might not be under the current management team, but that time will come sooner than most of us think. Patriotism can only go so far and Nokia is trying to run a business with a global shareholder base after all.
If it were not absurd enough that entrepreneurship is seen as being comparable to a riskless investment as the debate suggests, most people taking part in the conversation comment as if entrepreneurs would pay zero tax on the dividends up to the €90,000 mark, when they are really paying a good 26%. Secondly, Sinnemäki is telling us that to counterbalance the tax, entrepreneurs can deduct losses from the tax they pay. I have yet to find an entrepreneur who wants to build a company only so that he can make a loss.
To Sinnemäki’s credit, I do agree that the current tax code has a hole that for example many doctors use when they take out most their pay in dividends instead of pay. That said, the future of Finnish growth entrepreneurs should not be jeopardised because of a badly designed system. Politicians have a tendency to go from one extreme to other and I’m afraid Finnish entrepreneurship could end up paying for this.
More Leveraged Companies
In addition to the very negative message the double taxation would send to Finnish would-be entrepreneurs and the very significant economic disincentive to starting a company in Finland, the double taxation would also likely lead to more debt.
The world of double taxation would lead companies to take on more debt on their balance sheets in order to deduct the interest in taxation. In the light of the de-leveraging which the global financial architecture has been forced to undergo during the past few years, it would be absurd to incentivize more debt leverage in companies. The next time we would hit a rough patch in the global economy, our export focused companies would not even have the small cushion in their balance sheets they had in 2008 to absorb that hit. A lot more bankruptcies would ensue. Have we already forgotten the 1990’s recession and its lasting effect on our entrepreneurial culture? Even without a rough patch in the economy, the companies would build this lack of cushion on their balance sheets into their decisions to hire and would consequentially hire a lot fewer employees knowing they could not carry the cost structure if the sales dipped even slightly.
Even if Sinnemäki’s comment was pure populism in waiting for the change of prime ministership and the next parliamentary elections, it sets a dangerous example and signals a complete lack of understanding of the role that entrepreneurship plays in a healthy economy.
The Green Party, and any other political entity that considers favoring the double taxation of dividends would be smart to pause and reconsider. Finnish entrepreneurs might not be the most vocal in daily politics since running a company is full time job and does not stop at 5pm, but when put between a rock and hard place we know how to vote. Knowing there are also a lot of smart people in Sinnemäki’s party, I’d hate to see the whole party get a stamp on its forehead for a single lost sheep.