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I thought of writing about this to ArcticStartup since it relates to the startup ecosystem so closely, but decided to post it on my personal blog as it is such a strong personal opinion.

Taxes in society work to distribute wealth, run governmental organisations to generate services for everyone, enable running of cultural services that wouldn’t be possible under market conditions, make education free in our country and for a ton of other reasons. In the end, they are in place to make our society a better place for everyone to live in.

Finland, like most civilised countries aim to treat all its citizens and organisations in an equal manner. This guarantees equal opportunities and rights for everyone involved. However, in some cases it is not favorable for the society as a whole to apply the same set of rules to everyone. Examples of this can be seen in our progressive taxation, the more wealthier you are the more you pay taxes in relation to your income. Everyone understands that while those being taxed more understandably do not prefer to be taxed more, but it works extremely effectively to generate more wellbeing for everyone else – thus justifying the unequal treatment of tax payers.

Like progressive tax, I strongly believe there is a case for a similar kind of unequal treatment in taxes for entrepreneurs. I’m talking about entrepreneurs here in general and not distinguishing between growth entrepreneurs and other kind. Unfortunately very few people in our society have realised the importance of this group to our social well being.

While two thirds of the Finnish population work at large companies, it may not be obvious to them that 95% of all companies registered in Finland are SMEs. Not only does one third of the population directly depend on entrepreneurship as their prime source of income, it is a key component of our economy in the way of generating employment, goods and services that larger companies will never engulf on. To generalise, we can say that entrepreneurs are a key component of welfare in our society.

In the recent years Finland has taken many steps toward making entrepreneurship more appealing, having finally realised its importance as large companies aren’t always employing as planned. However, there is a very simple yet extremely effective mechanism left unused that I strongly believe would only bring value to our society in the long term.

The mechanism I’m talking about, after the long prelude, is income tax for young companies. I have no understanding what so ever, when our government believes it is building a better society in the long term by taxing growing companies in the short term.

We have worked extremely hard for the past 2,5 years to build ArcticStartup the phenomenon it is today. We’ve put in tons of sweat and countless amounts of midnight oil to build it into a successful company. In 2009 we worked close to 10 months, alongside our day time jobs to make the machine turn – effectively keeping its costs down to a minimum. We also managed to sell quite a bit of advertising and visibility to our partners who have received very valuable coverage in a tough niche. All this hard work has resulted in us creating a profit for 2009, which does not carry over too well through 2010 as we’re putting in a lot resources to developing our business further.

All our hard work, countless hours and determination give us the opportunity to enjoy a very limited profit for 2009 which is then taxed on by the government. While I understand that taxing is in place to build more value, I believe in this case it does dramatically more harm than originally thought.

While the amount of taxes we accrued is very reasonable, I think there are justified reasons why young companies should not be taxed on their income during their first years of infancy. The very essence of effectiveness; startups have a chance at success because they create things thousand times more effectively than large organisations could ever do. This applies to the government as well, entrepreneurs make a lot more good with the money than our governments could ever do – at least on this scale.

It’s not recommended to whine in length about something if you don’t offer a solution. Here are my 2 cents. Any form of legal corporate entity that is under three years of age or has accrued less than 500 000 euros of profit and keeps that money in the company (as opposed to paying out dividends) – should not be taxed on their possible profit. While this might lower the amount of income tax the government collects from young companies, it supercharges them for success in the long term.

This single change in tax law, would make the Government of Finland our economy’s largest venture investor. This would create incredible implications in the long term through more possibilities for entrepreneurs to succeed, which in turn would make entrepreneurship more appealing and in the end – it would make our society a much better place to live in.

I was walking home last night from the Startup Christmas party in downtown Helsinki, organised by GrowVC and Aalto Entrepreneurship Society, I came up with an interesting way of looking at our innovation system from the national perspective. Innovation, as we all know, is an extremely hot topic among politicians as they try to dig into the best future sources of government tax.

As many know, I’m a huge fan of growth businesses and try to promote them through ArcticStartup with our team. I’m such a big fan of the whole ecosystem that I believe that we’ve only began to touch on the possibilities it has for our economies and ultimately, our society. We talked a lot about the Finnish innovation system in the Christmas party and while there were some appraisals, it was mostly criticism of some sort on how to make the system better. Pretty much the usual stuff if you look at anything in our societies these days.

This got me thinking about the difference in supporting innovation in regular entrepreneurship and growth entrepreneurship. While it is very hard to define the points in which a company becomes a growth company – let’s for the sake of this blog post decide that first and foremost it is the passion of the entrepreneurs that counts and after that the results the company has achieved on an annual level. Say a 10-15% increase in revenues annually could be thought of being a very growth oriented company.

One of the problems we face is that not many people are able to distinguish between these two – growth entrepreneurship and regular entrepreneurship. The latter could be said to represent the majority of the companies in Finland and in some way the capitalist system itself. Growth entrepreneurs are those who take incredible risks and have incredible ideas on how to change the world and make it a better place. Almost all fail, but a few successful ones are able to take incredible leaps and do wonders to the way we live.

Now, not to wander about too much, I’d like to focus back on innovation and how it is supported in many economies. While there are a lot of incentives and tools available for businesses to leverage risk with the help of the governments – they are usually equally shared among the entrepreneurs in the society. Some of the help goes to growth entrepreneurs and some of the help goes to regular entrepreneurs.

What’s wrong with this equation then? Well, my argument is this: innovation in large companies is like inflation – it’s natural and it always happens. If it doesn’t, the companies don’t stay big very long. All the competition in the field is innovating as well, to keep ahead of their rivals. It’s natural and built into capitalism for survival. Where as in growth entrepreneurs they are usually in non-existent markets where consumers don’t realise the need for such a product or service and there are always extremely high risks and non-existent chances of pulling the concept through.

So how does supporting innovation fit into this framework then? Well, if you look at large companies – innovation in them is like inflation, it’s built into the system – they are bound to do it anyway. My point here is that large companies should not be supported by government money that much compared to more disruptive and higher risk ventures. These are the unnatural companies looking to do something new, and a lot of life support is usually needed to lift these companies off the ground – if the idea in the first place is any good that is.

So to finalise my random rambling here, I do think we (and perhaps other countries as well) should look into our innovation system and take a few steps back to think about the ways we are spending our tax payer money. While I do believe these organisations are of great value, their clients could be thought out more specifically on the potential of return-on-investment. If you look at it, the returns on innovation in large companies are not usually that great compared to growth companies who are able to create thousand-fold returns in new or near non-existent markets. While many of the growth companies fail, I’d still bet my tax payer money on them in the future for innovation.

I’ve been thinking about a couple of issues regarding our economy for quite some time now, but it was only until Marja Heikkinen-Jarnola’s column that I decided to blog about them. Heikkinen-Jarnola is a controller at the Ministry of Transport and Communications. I’ll leave the other issue for a new blog post so I won’t bore everyone to death here.

The column had a very simple point that she is doing a doctoral thesis on as well. She argues that governments’ books should be kept so that they follow the same accounting rules as corporations do. She argues that if Finland would be put to follow the same accounting rules -our country would have to declare for bankruptcy. I’m not surprised.

The thinking behind all this is that you have to balance your expenses to your income, just as companies have to. Well, not every year but if companies decide to neglect this simple rule for long enough – they’re forced out of business. Governments accounting rules are different – there are no bigger organisations that govern the ways their books are kept (roughly put).

The shocking fact is that according to Heikkinen-Jarnola’s study, would Finland have followed corporate accounting rules, Finland would have had only one positive year (in term of profits) between the years 1999 – 2008. These have been very successful years for Finland, not counting the dotcom bubble years 2001 and 2002. These figures exclude the sales of government owned corporations and dividents from government organisations. Looking at our economy from this perspective – we’re constantly running a slight deficit in terms of national income. Not a very positive thing in the end.

The government’s role with regard to the economy is to keep the annual budget balanced. That is at least how I believe many see it. If someone would introduce a CEO to me whose job is to keep the company’s budget balanced, I’d think there’s got to be something wrong with the business – why aren’t they trying to grow or create a profit?

To keep the budget balanced, if there is a possibility of deficit (like there is this year), governments take debt. Who pays the debt? The taxpayers naturally. In a way, each of us is a shareholder in a corporation called Finland and we’re not very active in running our company. This year will accrue each shareholder of Finland a future liability of approximately 2600 euros (Finland takes around 13 billion euros of debt this year to balance its budget).

Update: Just to clarify – I’m totally for Heikkinen-Jarnola’s initiative. I’m a big supporter of running governments more as large corporations.