President Obama, in his State of the Union Address last week, indicated that he would assist small business, particularly to encourage their hiring of additional workers. Two days later he proposed a $33 billion tax credit to small businesses that increase their hiring. I consider small and medium size business the backbone of any dynamic economy, so I sympathize with the President’s desire to encourage these businesses. However, his proposal is not a good way to do this.
Obama’s aims are laudable: to simultaneously increase employment, reduce unemployment, and encourage the expansion of small and medium sized businesses. Yet, as an employment-increasing plan, the President’s approach has many problems, and is likely to have only limited impact. This is partly because while $33 billion is a lot of money, it is less than ¼ of one percent of American GDP. Yet even a much larger sum would have a small impact on employment. One reason is that the subsidy proposal gives small business some incentive to fire some employees, and then later to replace them with unemployed workers for whom they can collect the subsidy.
The unemployed hired under the subsidy program would likely receive higher pay than they would get otherwise because companies compete for these workers to qualify for the subsidy. Some workers might then remain unemployed rather than accept jobs in order to get the higher pay after the program is implemented. Employed workers at small (and even large) businesses might quite their jobs and become unemployed in order to become subsequently employed at other small companies in order to become eligible for any higher wages received by new hires. The President is aware that efforts will be made to game the proposal, and he proposed various safeguards. However, new ways will be discovered to get around the restrictions that would reduce the net job creating potential. Further efforts to close loopholes would lead the government to become more and more involved in the employment decisions of companies.
Smaller businesses are an important source of innovation and progress. Businesses like Microsoft, Wal-Mart, Apple, Google, and many others introduced game-changing innovations when they were very small that enabled them to grow very large, and they raised overall productivity. This is why it is so important to promote startups and other smaller businesses in an efficient and effective way. An effective approach has several components, and overall the US looks quite good compared to other countries. According to World Bank estimates, the US ranks 8th out of the more than 180 countries they consider on their overall index of the ease of starting a business, whereas, for example, Italy ranks 78th, and China 89th. On the other hand, the US ranks only 25th on the ease of getting construction permits, and 61st on taxes.
The US is tied for first place on the ease of employing workers. It is much easier for American small and medium size business to reduce their employment during bad times than it is for similar-sized companies in Europe, Latin America, or India. This helps explain why employment fell, and unemployment rose, more sharply during this recent recession in the US than in say Germany, Italy, and many other countries that have much less flexible labor markets, even when other countries experienced larger recession-induced falls in GDP.
Unfortunately, several proposals in Congress, and others mentioned by the President, would make it less attractive to start a business, or expand a smaller business. Although it is especially unclear after the election of a Republican senator from Massachusetts what any final health care bill will contain, some of the proposals would require all companies, with few exceptions, to provide health insurance for their employees. The fact that many small businesses do not now give their employees health insurance indicates that such a requirement would raise their costs, and reduce their employment.
Small and medium sized business owners are sensitive to capital gains taxes, increased taxes on larger incomes, and high rates of taxation on estates. Yet leading members of Congress have advocated increases in capital gains taxes, adding an additional tax on ”high” incomes, and a return to higher estate taxes. These proposals would hurt all higher income persons, but might be particularly discouraging to startups,and to the expansion of smaller businesses.
I believe that smaller businesses can competes effectively against more sluggish larger and more established businesses without getting special privileges, such as the President’s additional proposal to subsidize bank loans to small businesses. However, small business does thrive much better in an environment where success is not taxed at high rates, and where regulations and mandates do not have a disproportionately large effect on their costs and profits.