Since the market lows of the Global Financial Crisis in March 2009, economies have grown significantly during what many called the longest bull-run in history, largely driven by quantitative easing.
However, the ominous inverting of the yield curve in 2019, the US/China trade war and a constant barrage of Trump’s erratic tweeting, provoked many economists to begin warning of an impending recession.
The sudden explosion of the COVID-19 pandemic in 2020 and the complete shutdown of economies around the world turned out to be the catalyst, forcing countries into an unprecedented economic recession. In response, governments and central banks around the world announced massive stimulus packages in an attempt to support economies. This has resulted in the level of government debt around the world to increase significantly, with the government debt in the UK exceeding the size of the UK economy in July 2020 (105.5%) for the first time in more than 50 years.
A recession is often characterised by a significant slowdown in economic and business activity, which can lead to rising unemployment and a fall in consumer spending. Technically, a recession is where there is a decline in Gross Domestic Product in two successive quarters.
During an economic slowdown, investors typically lose their appetite for risky assets such as equities, evidenced by the S&P 500 index falling by 57% between 2007 and 2009. In Spring 2020, the COVID-19 pandemic caused the S&P 500 to fall c.35%, albeit the index rebounded strongly due to the introduction of significant stimulus and the benefits to the e-commerce sector related to “working from home”.
But is there anything positive associated with what is generally a natural part of an economic cycle?
An entrepreneur is often considered to be someone who identifies opportunities and is willing to take a risk in order to create value.
As one might expect, many studies have been undertaken which show that entrepreneurs create disproportionate numbers of innovations and jobs, which in turn can lead to faster rates of economic growth.
So, what does an entrepreneur think when faced with a recession? Is it an opportunity or simply a storm to be weathered?
One view is that entrepreneurship is pro-cyclical and, therefore, likely to suffer during an economic downturn.
When economies are growing, they are often accompanied by increasing productivity and wealth. This can lead to individuals becoming more willing to bear risk, allowing them to make the jump into entrepreneurship. Furthermore, the anticipation of future prosperity can lead to lenders being more willing to fund higher risk projects, which is often a critical environment for start-up businesses to thrive. Innovations by entrepreneurs can in turn create opportunities for others, leading to subsequent innovations and further economic activity.
Therefore, during a period of reducing economic activity, one can see how the inverse would also be true, with the above factors having a negative influence on entrepreneurship.
However, one can take a contrasting view when you consider why someone becomes an entrepreneur or perhaps what pushes them to finally make the jump.
It is thought that there are two types of entrepreneurs. Those who are born from the existence of opportunity and those who are born out of necessity.
When deciding whether or not to take a risk, it is natural for an individual to consider what they have to lose - leaving employment and a stable salary can be daunting. In times of recession, rates of unemployment increase which can remove this potential barrier, encouraging individuals to take the entrepreneurial jump which they may have been thinking about for some time. This is supported by a study conducted in the US which found that the Great Recession saw the largest increase in entrepreneurship of any period in the study’s 14-year time frame (1996 to 2009). The formation rate of new businesses went down in 2006, in the lead-up to the recession, and started to increase in 2007 before spiking in 2008. It hit its peak in 2009, when the rate was 17% higher than three years earlier.
Furthermore, downturns are typically accompanied by significant monetary policy easing. This reduces the cost of capital, encouraging people to borrow and enabling them to fund their new business ventures.
Interestingly, where new businesses are created out of necessity, a subsequent period of recovery can be accompanied by the dissolution of some of these businesses. This is because some of the businesses do not necessarily have the longevity or potential compared to those created out of opportunity. Hence, as an economy recovers and conventional employment opportunities become more readily available, some of those people make the decision to move away from riskier entrepreneurial activities and back into employment.
Impact of tax policy
Governments have the power to increase and decrease taxes, or indeed add or remove specific taxes altogether.
It is widely known that generally a reduction in the tax burden can lead to increased aggregate demand within an economy. In times of recession, it is demand which is often subdued and needs to be reinvigorated in order to encourage future economic growth.
But how does tax policy affect entrepreneurship?
Tax policy can create incentives for people to be entrepreneurial and take risks. It can either work by incentivising the creation of a business, incentivising people to invest in those businesses or perhaps reducing the tax burden upon an exit which increases the potential upside when considering a business start-up.
A study carried out in the US, which looked at the impact of personal savings on the possibility of starting a business, found strong evidence that higher levels of personal savings significantly increases the likelihood of new businesses being started.
Interestingly, the nationwide lockdowns in 2020 resulted in many households becoming “forced savers”, unable to spend on holidays, socialising and commuting costs. Some households also consisted of “fear savers”, who limited their spending over concerns about the economic consequences of COVID-19. The savings rate, therefore, jumped significantly as a result.
When an entrepreneur comes up with a new business idea, it can often be hard to convince others, possible investors, of the potential of the idea. Investors may want to sit on the sidelines until there is a proven concept or track record. Therefore, when someone decides to start a business, the availability of personal savings is critical. Without savings, the business may not make it off the ground.
The link between entrepreneurship and savings potentially highlights how tax policy could influence future entrepreneurship. For example, by reducing income taxes during a recession, it could enable savings rates to increase. Individuals having greater personal savings means that they are potentially better positioned to take advantage of business opportunities when they present themselves, which can in turn create the businesses and employers of the future.
Reliefs like Enterprise Investment Scheme (EIS) could be enhanced to further encourage private investors to fund small start-up businesses, giving them the critical early capital they need in order to be successful. Perhaps the relief could be extended so that loans to small trading businesses also attract beneficial tax treatment?
Entrepreneurs’ Relief (“ER”), now renamed as Business Asset Disposal Relief, and Investors’ Relief can apply to reduce the rate of Capital Gains Tax from the main headline rate of 20% to 10%, where there is a qualifying disposal of a trading business. This helps to increase the potential upside. However, the government decided to reduce the lifetime limit of ER from £10m to £1m from 11 March 2020. Their view was that the change would improve the effectiveness and value for money of the relief, ensuring the government continues to encourage genuine risk takers and entrepreneurs’ in a fair way, with over 80% of those using the relief unaffected.
Therefore, whilst many are currently focused on central banks, the setting of interest rates, as well as government fiscal stimulus, one must not forget that governments can also take action to stimulate future entrepreneurship through effective tax policy. By creating the right incentives and putting entrepreneurs in the position to be able to take advantage of opportunities, they can lay the foundations for future economic prosperity.
The question for the government is whether they are prepared to reduce tax rates at a time when the budget deficit and government debt is soaring. Will they feel the pressure to raise taxes in an attempt to reduce the debt burden? Speculation of an increase in capital gains tax rates is being widely talked about, albeit this is unlikely to result in any significant increase in tax revenue relative to the size of the government debt.
With savings rates having increased in 2020 due to the pandemic, banks still having the appetite to lend, along with a significant jump in unemployment (albeit cushioned by the furlough scheme), there would appear to be relatively strong evidence to suggest that we could see a notable increase in entrepreneurial activity over the next few years. With a supportive government and tax policy, this could very well be enhanced further.
Calibrate Law is a multi-disciplinary law practice providing an interconnected approach to law, business and tax. Our experts work as part of your team helping to resolve conflict, safeguard futures and realise opportunities.
 Congregado, Golpe and Parker 2009
 Audretsch and Keilbach, 2004, 2007; van Stel, Carree and Thurik, 2005
 Rampini (2004)
 Robert W. Fairlie (2013)
 Ghatak, Morelli and Sjöström, 2007
 William M. Gentry and R. Glenn Hubbard, “Entrepreneurship and Household Saving,” Advances in Economic Analysis & Policy, Vol. 4, No. 1, 2004
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COVID-19 recession a catalyst for entrepreneurial activity?
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