Small enterprises and economic policy

Annotation
Institutions such as strong property rights and the rule of law are important for both long-run economic performance and short-run volatility. Developing good institutions is generally viewed as a desirable goal, but there is no agreed road map for such changes. This paper suggests that, at least for former communist countries, the right way to begin is by lowering the barriers to entry into the formal sector for small-scale entrepreneurs. Taxation, regulation, and establishing property rights must be taken together. A good way to cut this Gordian knot in one stroke is through moving to a low lump-sum tax on small business. Lower taxes have a positive direct effect and an additional indirect benefit of lowering regulatory burdens and corruption. Former communist countries that have implemented such taxes have quickly created a large small-scale business sector. These policies have economic advantages, but their most important effect is to change the political equilibrium, creating a powerful force for further institutional improvement.