City Journal

William Tucker
Under Siege: Small Business in New York
Small companies, the lifeblood of the city's economy, are moving to the suburbs, fleeing New York's high taxes and burdensome regulations.
Autumn 1992

EDITOR’S NOTE:
New York City has great natural advantages as an incubator of small companies. Nonetheless, it lags far behind the rest of the nation in the growth of small businesses, and many of those already here are leaving for the suburbs. In fact, New York has fewer small businesses than it did in 1969. If New York is to grow new industries that will provide jobs and prosperity for the future, it must reduce the crushing tax and regulatory burdens that are driving small companies out of the city.

Louis Powsner still remembers the day the Con Edison meter reader showed up at his men’s store in Coney Island. “He took one look at the bars and gates and said, ’This is a regular Fort Knox you’ve got here.’ Then he went down to read the meter. When he came back up, he grabbed me by the head, put a knife to MY throat, and stole everything out of the cash register, plus my wedding ring of 44 years.

“It turns out he was a guy who had been fired from Con Ed three years before. I picked him out of a lineup the next day. It’s the 76th time I’ve participated in an arrest since I took over this store.”

Powsner, who serves as chairman of the Kings County Board of Trade, has the typical fatalism of a New York small business owner. “I run what’s left of a men’s shop on what’s left of Mermaid Avenue in what’s left of New York,” he says. Crime is his number one problem. Still, there are other things to keep him busy.

“I once added them all up and found I pay 17 different kinds of taxes and fees,” he says. “Did you know there’s a $125 annual permit fee for having an illuminated sign in front of your store? And there’s another one for having air conditioning? Then there’s the sales tax, the property tax, the income tax, the commercial occupancy tax—we’re basically just in business to collect taxes for the City government.

Yet there is a growing realization that the future of New York City depends on whether small businessmen like Louis Powsner can survive. For many years, New York City’s economic development policy has concentrated on retaining large employers through individual negotiations and special tax breaks. Recently, however, the Dinkins administration has signaled a change in direction. The Mayor has appointed an Interagency Task Force on Small Business, which held a series of Town Hall meetings with small business representatives this summer and is exploring ways to improve the business climate.

“We’ve realized that it’s not enough to hang on to what you’ve already got,” says Barry Sullivan, deputy mayor for finance and economic development. “The most important thing cities have to do is keep growing new businesses from within.” Thus far, however, the administration’s only major small business initiatives have been a $5 million loan-guarantee program called the Small Business Reserve Fund and a $2.4 million “microloan” program to lend sums of $5,000 to $50,000 directly to small businesses.

In hitting upon small business growth as a key to economic development, the city is discovering an economic truth that is already well-established.

“We’ve known since 1979 that over 80 percent of the nation’s job growth occurs in companies with fewer than one hundred employees,” says David Birch of Cognetics, a small Boston research firm generally credited with this discovery. “The Fortune 500 are basically companies that have topped out. Their employment actually declined 20 percent during the 1980s, at a time when the economy as a whole added 20 million new jobs. The big companies are always shedding skin. It’s the incubation process for small companies that matters.”

The theory that small businesses are the lifeblood of a city’s economy and that cities must constantly renew themselves from within, rather than attract mature businesses from without, has a well-established pedigree. The most eloquent explication was Jane Jacobs’s book The Economy of Cities, in which she argued that cities have always been places where new industries were invented before being “farmed out” to the countryside when their growth eventually made them too cumbersome to maintain within a dense urban environment. Cities, Jacobs explained, are the natural incubators of new businesses—places where the rapid pace of life, face-to-face contact, and concentration of ambitious people come together to create new ways of doing things.

Lower Manhattan, for example, was once the seedbed of the electrical industry. Thomas Edison set up his first power generating station on Pearl Street, and the iron facades of SoHo housed the sweatshops of the nation’s electrical industry. Today they are all gone. Power plants are built in Westchester County or far upstate. The nation’s electrical industry left four decades ago for Utica and beyond.

The city government’s response to the exodus of the electrical industry is emblematic of its failure to understand the dynamics of entrepreneurial innovation. Until the 1970s, the city refused to allow the area to be re-zoned for any other use. Like the cargo cults of New Guinea, who built huge airports in the jungle and waited for airplanes to land, zoning officials insisted on retaining the area’s industrial classification, as if waiting for some new electrical industry to drop out of the sky. Only when zoning was informally relaxed did SoHo evolve into a thriving artistic community.

The city government continues to follow the same approach on lower Sixth Avenue, on the waterfront, and in dozens of other areas that have fallen into decay and ruin. Manufacturing zones usually signify vacant lots. Where somebody has gotten really ambitious, there is a parking lot. Jacobs’s analysis of the constant need for cities to give way to the future makes more poignant Seymour Durst’s acid remark about lower Sixth Avenue: “Why not try agricultural zoning?”

Because of the city government’s misguided policies, New York has failed to exploit its great potential as an incubator of small business. During the 1980s, the number of small businesses grew by a mere 4 percent in New York City, compared with 24 percent nationwide. The city’s 10 percent increase in employment from 1978 to 1987 came almost entirely from Wall Street and city and state government. Moreover, the city actually has fewer small businesses today than it did in 1969.

While more than 95 percent of New York City’s businesses employ fewer than one hundred employees, larger companies provide 55 percent of the jobs. “The role of companies with more than five hundred employees is proportionately larger in New York than anywhere else in the country,” says Jim Brown, a researcher for the New York State Department of Labor.

During the 1980s, small firms accounted for 75 percent of job growth nationwide and 79 percent in New York State; for New York City the figure was only 22 percent. “The difference between the role of small businesses in New York City and the rest of the nation is striking,” says Samuel Ehrenhalt, regional commissioner of the U.S. Bureau of Labor Statistics.

New York City does retain its natural advantages as an incubator for some types of small business. In the financial service industries, for example, a Port Authority study found that Manhattan alone accounts for 38 percent of new businesses in the 17-county metropolitan region. “What seems to be happening, however, is that these businesses are leaving fairly rapidly,” explains resident economist Stephen Leschinsky. “The favorite locations are Westchester and Suffolk Counties in New York and Hudson and Bergen Counties in New Jersey.”

Tracing the history of a few of these companies gives an idea of what makes the city an unattractive place to do business.

In the 1970s, Mario Gabelli was a stock analyst for William H. Whitter, a small brokerage that later merged with Drexel Burnham. In 1978, Gabelli decided to start his own firm. He chose an office at 40 Wall Street. Building a remarkable track record for picking stocks, he soon expanded and moved uptown to 655 Third Avenue. “We needed the space and rents were cheaper,” explains Doug Jamieson, Gabelli’s executive vice president. By the late 1980s, Gabelli, known as “Super Mario,” was regarded as one of the four or five best analysts in the country. Last year he moved all but five of his 115 employees to Rye.

“We still have a research presence in Manhattan,” Jamieson says. “We have meetings there with people coming from out of town. You can’t replace the face-to-face contact, and it’s hard to ask people to schlep up here to Rye. But everyone else is up here.”

What attracted Gabelli to Westchester? “It was three things,” says Jamieson. “The quality of life, rents, and taxes.”

When the company moved two years ago it was paying $30 a square foot midtown; the going rate was $19 to $25 in Rye. The company escaped New York’s high taxes, including the city income tax and commercial occupancy tax, a tax on rents that businesses often cite as a particular thorn in their sides. Finally, there was the lack of a long commute for many employees, plus the elusive “quality of life.” “You can play basketball at lunch time up here,” Jamieson notes.

Hoenig Financial Investments, which started twenty years ago on Wall Street, moved its seventy employees from midtown Manhattan to Port Chester in June 1992. “We went public last October and suddenly had to become very responsible to stockholders,” says Dan Crowley, vice president for finance. “The taxes made it very difficult to stay in New York. Rents were high, too.”

“The rent tax [commercial occupancy tax] kept going up and up,” says Tina Aikers, assistant director of personnel at Central National-Gottesman, a paper manufacturer that is leaving Manhattan for Purchase. “The city just got to be too expensive.”

New Jersey seems to have lost some of its edge in attracting businesses since the state began raising its income tax to near New York’s levels. Connecticut, however, has been much more successful, thanks to an aggressive recruiting drive for businesses begun under Governor Lowell Weicker. “Most people concentrate on the new state income tax,” says Joe Cohen of the Connecticut Department of Economic Development. “But we’ve lowered both the sales tax and the corporate income tax. We’re trying to reduce the costs of doing business in the state.” In 1991 alone, 35 companies, large and small, moved or announced they would move all or part of their operations from New York City to Fairfield County. Among them were Elizabeth Arden, Maxwell Macmillan, AIG Financial, Revelation Technologies, and Turecamo Towing of Staten Island.

“The companies that are moving from New York City are doing it to save money,” said Janine Johnson, director of the Fairfield County Information Exchange, a business-sponsored organization. “They tell us they want to be near New York but not in it anymore. The quality of life and the educational system up here are a big attraction.”

Why has New York City—still a magnet for creative and ambitious people—turned into a place that successful businesses are eager to flee? There seem to be three key factors: high taxes, overregulation, and a deteriorating quality of life.

Taxes

Consider the tax burdens faced by a New York City architect who wants to go into business for himself. First, he must find office space. Although rents have gone down because of the real estate bust, they are still comparatively high in New York, partly a reflection of the city’s high commercial property tax. If the architect pays more than $11,000 a year in rent ($15,700 if his office is north of 96th Street or in the outer boroughs), he must pay the commercial occupancy tax, which is an additional 6 percent of his rent.

If he turns a profit, he must then pay the state income tax of 7.785 percent and the city income tax of 4.46 percent. The city then taxes his income again, through the unincorporated business tax of 4 percent. The total marginal city and state tax rate, then, is 15.335 percent.

If the architect were to set up shop across the river in Hoboken, New Jersey, he would be spared the city income tax and commercial occupancy tax, and would face a maximum state income tax rate of 7 percent. This top marginal rate would not kick in unless his profits reached $150,000.

Its crushing tax burden makes New York City the most expensive place in America to do business. Residents pay state and local taxes that are more than 50 percent higher than the national average, and the tax burden on corporations is almost twice the national average.

Remarkably, this high burden is spread across the entire spectrum of state and local taxes. Many states and cities rely heavily or one or two forms of taxation while others are low or nonexistent. Delaware, for example, has a high personal and corporate income tax but extremely low property taxes and no sales tax. Connecticut, until this year, had high property and sales taxes but no state income tax. But New York ranks high in every single category. The state and city rank first in the nation in state personal income tax as a percentage of income, first in state corporate income taxes, tenth in per capita sales tax revenues, and seventh in property taxes. New York’s combined state and local spending per capita is exceeded only by that of Alaska, which draws most of its revenue from royalties paid by out-of-state oil companies.

New York’s high taxes may be intended to “soak the rich,” but their actual effect is to make it extremely costly to start a business in the city. Although the Dinkins administration has been loath to admit that high taxes are harmful to the city’s economy, an April 1992 report by the Mayor’s Management Advisory Task Force acknowledged that “the sheer magnitude of the differences [in tax burden between New York and other cities] and the explosive rate of property tax growth in the city [have] become a significant impediment to economic development.” Business income taxes, the report noted, have risen from 0.8 percent of the gross city product in 1980 to 1.6 percent in 1991.

Even more ominously, the real property tax on commercial and industrial property increased steadily from 1.5 percent of gross city product in 1982 to 3.5 percent of gross city product in 1991.... Commercial property tax rates are now $4.48 per $100 of valuation, a rate roughly twice the average in Chicago, Houston, and Philadelphia.

Owners of commercial and industrial property now pay 53 percent of all property taxes in the city, although these classes of property account for only 37 percent of aggregate citywide property value. This differential between commercial and residential tax burdens is six times greater than that of Philadelphia and three times greater than that of Boston or Chicago, with most cities falling within this range.

On top of this, of course, is the commercial occupancy tax, a flat 6 percent tax on rent that is not levied in any other city. As the Mayor’s report notes, 56 percent of revenues from this tax come from the financial and service sectors, “the two primary sources of prospective growth in the city.”

Even the costs of energy—often cited as a big impediment for manufacturers—are driven largely by the city’s high levels of taxation. Fully 25 percent of Con Edison’s electric bills and 22 percent of gas bills represent state and local taxes. This compares with only 10 percent nationwide for electricity and 8 percent for gas. Similarly, 17 percent of New York Telephone’s gross receipts are state and local taxes. “Con Edison is the city government’s biggest tax collector—and everybody blames Con Ed,” says Don Mele of the Chamber of Commerce. “And I know one company that saw its phone bill go up $2 million a few years ago just because the telephone tax increased.”

New York has a host of other obscure taxes and fees, which are often nuisance applied in confusing or inconsistent ways. New York City, for example, recently created a monthly tax of $1 on beepers. And while unprepared food is not subject to state and local sales taxes, “snack foods”—as defined by the state Department of Taxation and Finance—are taxed, leading to some odd anomalies. Large marshmallows, for example, are classified as a tax-exempt “baking item,” while small marshmallows are a taxable “snack.” “New York has bureaucrats that do nothing but compile huge lists of foods they can reclassify in such a way as to expand their tax base,” says Cliff Busard, editor of the newsletter Sales & Use Tax Alert. “Sometimes businessmen will fight it out in court, but usually it’s cheaper and simpler just to pass the cost on to the consumer.”

A final, de facto tax takes the form of rising premiums for workers’ compensation and unemployment insurance. Workers’ compensation rates have skyrocketed 85 percent in the past four years, partly as a result of state policies (see “Compensation Games,” page 51). Businessmen complain that unemployment insurance rates are driven higher because officials seldom accept employers’ explanations for firing people. “Even if they steal from you, the unemployment office will try to get them benefits,” says Fred Levine, owner of The Copy Exchange, a 24-hour shop on Pine Street in Manhattan. It can also be costly to fire incompetent employees, because an employer’s premium rises rapidly with the number of ex-employees who have collected benefits.

In addition to hurting existing businesses, the high rate of taxation creates an incentive for new businesses to start outside the city and for people to avoid taxes altogether by running off-the-books businesses that pay no taxes and have an unfair competitive advantage over legitimate firms.

“Over the past three years, we’ve lost 8 florists in the Bronx, 16 in Manhattan, 11 in Queens, 9 in Brooklyn, and 3 in Staten island,” says Steve Parlavantzas, president of the New York Retail Florists Association. “They’re being killed by street vendors, who crowd around our stores, taking business right from under our noses. They’re not paying taxes, they’re not paying any overhead. How are we supposed to compete against them?”

Regulation

Claudette Duff, who runs the Homeport Market in Staten Island, was fined $2,000 by the city’s Department of Environmental Protection for playing music that was audible outside her store. “I didn’t even know there was a law,” she says. “The police were here a week before and told us we could play if we kept the volume down to a certain level. Then, two weeks later, another city official walks in and hands us the fine.”

Duff was among the small business owners who attended the Mayor’s Town Hall meeting on Staten Island in late July. With the entire Interagency Task Force on Small Business present, there was barely enough room on stage to accommodate the municipal contingent. Seventeen people crowded two-deep trying to answer questions from angry merchants.

“My brother-in-law invested his life savings in renovating a building for a delicatessen, and for the last six years the city government has refused to give him a certificate of occupancy,” complained Ahmed Aziz. “One city agency tells us one thing and another agency tells us the opposite. How can you expect people to invest money under these kinds of conditions?”

Small businessmen complain not only that there are too many regulations, but also that they are so complicated and overlapping that conflicts between them often cannot be resolved. Moreover, the city often uses regulations as a way of collecting even more revenues in the form of fines.

“Right after the last budget crisis, the city government decided it needed more revenue,” says Harold Waterman of the Brooklyn Chamber of Commerce. “So it started cracking down on the ’18-inch Law,’ which requires a property owner to keep the sidewalk and road clear of garbage 18 inches into the street. People were being billed $20,000 to $30,000 for back fines. There were several well-publicized raids on small bodegas in the Bronx that probably owed more than they were worth. All this had nothing to do with keeping the streets clean. It had to do with balancing the city’s budget.”

The Sanitation Department relented, under extreme pressure from small businesses and property owners. It now posts specific times when it will inspect blocks for garbage on the sidewalk. But merchants still complain of unfair treatment. “They just jump out of the car and start writing tickets,” says Jack Michaels, owner of a small Times Square jewelry store. “You can’t argue with them—there’s nothing you can do. They don’t even look at the sidewalk.”

Restaurant fines work much the same way. “The thing that we find objectionable is that they go right up to the maximum on the first offense,” says Fred Sampson of the New York Restaurant Association. “We’re being held to a higher standard than a brain surgeon. The inspectors walk in and find five or six infractions and you’re out $500 to $600 just like that. The city government collects over $1 million a year from health inspections.”

City regulations can be extremely burdensome, even when enforced in good faith. Just to start a business, one must run a gauntlet of restrictions and permit requirements. In ten industries surveyed by the New York State Office of Business Permits, the average number of permits required to do business was 35.

Simply obtaining the permits and licenses required to open a restaurant can take a year. Robin Gross, a Manhattan lawyer who has advised small businesses for twenty years, describes the procedure for getting Con Edison to turn on the gas at a new restaurant:

First you have to get your blue card from the city plumbing inspector. This means the plumber has certified that the gas pipes are up to code. But the plumber can’t do this until you’ve installed your Ansul system—the range hood fire control mechanism. You file your plans for the Ansul with the Buildings Department. Once the plans are accepted, you get a number and walk your papers over to the Fire Department. They have to approve. Then you take the plans back to the Buildings Department and they perforate and seal. That means you can install your fire control. Once it’s installed, the fire department has to come to inspect. Technically, you need your plumbing inspector and plumbing contractor there at the same time. The plumbing inspector signs off and gives you your blue card, and then you can go back to Con Ed and ask them to turn on the gas. If you know what you’re doing, the whole thing takes about a month.

“None of these requirements is completely unreasonable,” says Fred Sampson of the New York Restaurant Association. “It’s just that the whole thing is so complex and mind-boggling. There ought to be one place where you can walk in and ask, ’What do I have to do to go into this business?’ And they ought to be able to tell you.”

Quality of Life

“After being robbed at gunpoint in front of my house, I finally decided I didn’t want to spend my life in Brooklyn,” says Stanley Reed, a Business Week reporter who recently moved to Connecticut, where his wife, Katherine, had already moved her small bond-touting business. “We felt a bit guilty about leaving at first, but not much anymore. There’s a whole community of Manhattan financial expatriates up here.”

Crime is among the top complaints of New York City businessmen. “We did a survey and found crime is costing small businesses more than $1 billion a year, or more than $5,000 per business,” says David Gallagher of Interface, a public policy group. “That’s mostly stolen merchandise, but also includes the added costs of insurance and recruitment. Twenty percent of employers said they had employees who had been assaulted going to or from work. It’s often difficult to recruit under those conditions.”

The deteriorating quality of life in New York—crime, disorder, inadequate public schools, badly maintained transportation facilities, deteriorating public parks, and other complaints about poor city services—drives many people to consider leaving the city. Mobile, affluent people, like the CEOs of both small and large corporations, are the most likely to move to the suburbs, taking their companies with them.

In some ways, the city is at a natural disadvantage with respect to quality-of-life concerns. The suburbs are, by nature, places people go to escape the unpleasant aspects of high-density urban living. Still, there is much the city could do to improve the quality of its residents’ lives, and if the suburbs will always have a certain appeal, that is all the more reason why the city should not place itself at a competitive disadvantage through high taxes and burdensome regulations.

Restoring an Entrepreneurial Culture

In the August 1992 issue of Inc., author John Case reviewed “The Best Places in America to Own a Business.” “None of the experts I consulted mentioned New York as a good place to start your own business,” he says. New York has no Silicon Valley, no East Cambridge, hardly a single pocket of technological innovation. “We were keen on Manhattan, but found it next to impossible to locate there,” says Philip Goelet, cofounder of Molecular Tool, a genetic engineering company that now employs 11 people. “Our costs in New York were extremely high and there were zoning problems in working with different chemicals. Once the landlords heard we were seeking a license to deal with radioactive chemicals, they became nervous.”

Goelet and co-founder Michael Knapp, both research scientists at Columbia, operated their firm out of Hoboken for two years before moving the whole business to the Bay View Research Facility in Baltimore, operated by Johns Hopkins University. “Other cities have created industrial parks and made a real effort to streamline the location process for high technology,” Goelet says. “But New York just isn’t prepared to handle it. If you’re not finance, insurance, or real estate, they don’t know what to do with you.” Ironically, city officials cite genetic engineering as a potential growth area for the Manhattan economy.

Goelet’s experience exemplifies the fundamental problem: New York City’s predominant political culture simply does not understand the importance of entrepreneurship and technological innovation. Though the city once honored commerce and industry, since the 1930s the prevailing culture has held that entrepreneurs are essentially greedy and conniving, and that the true heroes of the municipal scene are the bureaucrats who protect the average citizen from predatory business people.

Most businessmen, however, are average people. At any of the Mayor’s Town Hall forums, the well-dressed, educated (and obviously well-salaried) officials on stage all represented the city government. The scruffy, less affluent people in the audience—many with foreign accents—were the “business community.”

The entrepreneurial spirit remains alive in New York, reinforced by an influx of immigrants eager to realize the American Dream. But the tax and regulatory burdens imposed by the city government ensure that many businesses will continue to flee as soon as they can afford to. And while the Dinkins administration’s new-found interest in small business is encouraging, it is easy to predict where its policy of lending money to small firms will lead.

If the business receiving a loan is a small retail shop—a restaurant or a hairdresser, for example—it may succeed, adding a bit of vitality to the city’s economy. It may also fail, which means taxpayers will pick up the tab. If small New York firms find it difficult to secure loans without government help, it is because the loans are risky, reflecting the trouble small businesses have surviving in the city.

If the city lends money to a small firm that draws many of its customers from outside the city—that is, one that doesn’t have any real reason to be in New York—then the firm will probably leave town as soon as it grows big enough that the tax advantages of locating elsewhere outweigh the cost of a move. New York City’s tax-funded loans will end up watering the lawns of Westchester and Connecticut.

The outlook for small business in New York is not likely to change until the predominant culture changes. Business must be seen as a worthy human endeavor in itself, rather than as some exotic plant that must first be watered by government and then harvested for tax purposes when it has matured. A serious policy to encourage small business must begin by reducing the burdens of taxes and regulation.

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