Subsidies to Small Business? Becker

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 8^th 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 78^th, and China 89^th. On the other hand, the US ranks only 25^th on the ease of getting construction permits, and 61^st 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.

 

 

Comments

[anonymous]

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[Jake]

Many of Obama's policy proposals (not to mention the very fact that he got elected to the White House) are a testament to the ignorance of the large segment of the electorate who are too young to remember how bad things were under Jimmy Carter. Back in the late 1970s and even into the early 1980s, the government experimented with so-called "targeted job tax credits" for employers who chose to hire unemployed people. For the most part the jobs did not outlast the time period that employers had to keep the new hires on the payroll in order to earn the tax credits.

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[Seamus Brennan]

Interesting point about the relative ease with which employers in the United States can terminate workers to cover losses. Europeans and Asians certainly enjoy a more generous work environment. Not sure if I agree with your theory about workers quitting their jobs to hold out for higher wages at a later date. Most workers think in the short run since they are faced with credit card payment, mortgages and putting food on the table.

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[Brian]

businesses might quit*e* their jobs

smaller businesses can compete*s* effectively

[st]

Small business not equal to innovation. US currently holding most promise land for high tech: The best technology by sectors, US rank 57% in Telecom (out of 100% with the best technology in the field), 70% in semiconductor, 87% in software, 85% in biopharmaceuticals, and 56% in clean energy. (source business week 2008 Dec). The problems are: (a) the hi tech not create enough sustainable jobs (more of bubble and bust hype). (b) current venture capital model (not say the early years of Apples and Microsoft time) flip and demand of 300% return on ipo are not the long term investment and job creation type (MBA school should take some blame). US got creative talents, but not solid investment in development and utilization, except Gov funded agencies, such as NASA. Just look who dominated the solar cell technology? Where was it invented? The long term investment of electrical hybrid car would never occur in US. The cost benefit analysis conducted by the MBAs would killed it many times more. The US business is short sighted. increase shareholder value every quarter was taught by business school all over the country. (Plus GE share were flipped every 13 days.... does not create any stable shareholders that could be interested long term value).... Unless the fundamental focus of the business changed, there is no fix. Not enough money can solve the problem. (I am sure there are already game plan in the works to take some of the cream off the small busi program... I would not surprise if many small business just pop out in time to take funding and vanished right after the funding runs out).

[Peter]

You bring up some valid points. I agree with Seamus though, I think most workers would hold onto whatever job they have in order to be able to provide bread on the table. Being that nothing is guaranteed in today's economy, I'm not sure how much of a risk workers would be willing to take in order to maybe get a higher payroll.

[Randy]

I dont know how this job Problem is going to turn out but I do Know we need to get people Back to work...

[Tim Bartik]

Professor Becker:

Many of your comments might be applicable to some version of employer tax credits, but are not applicable to President Obama's proposal given its specific design features.

For example, Obama's proposal does not provide any incentive to fire some employees and replace them with unemployed workers because: (1) the credit is based on net employment increases since a base period; (2) the base period is 2009; (3) the credit is based on any net employment increases and is not tied to hiring workers who are unemployed. Your comment is applicable to a quite different proposal, by Senators Schumer and Hatch, which is a hiring credit for the unemployed.

As always, the devil is in the details.

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[shakti]

President Obama did well and i like his strategies about small businesses. So that's why US is on top in business because there the high ranked persons taking interest in business and in the development of country. But this is not happen in all over the world. But with the growth of US every country take part in this growth. Anyway you have posted a stunning post. Thanks for sharing...

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l good idea that Obama proposed to give a subsidy to small businesses, this will help make you stronger in the market.

[George Grant]

Great Post!

[George Grant]

It seems that incentives for small business to hire people is exactly what is needed during this critical period. It is a good plan that will help to move the economy forward

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I think subsidies for this problem is not required.

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[sesli chat]

Interesting point about the relative ease with which employers in the United States can terminate workers to cover losses. Europeans and Asians certainly enjoy a more generous work environment. Not sure if I agree with your theory about workers quitting their jobs to hold out for higher wages at a later date. Most workers think in the short run since they are faced with credit card payment, mortgages and putting food on the table.

[George Grant]

Thanks for your post. The notion of some people leaving their job in this economy to look for another at higher compensation without the "bird in hand" seems a little far fetched but thought provoking. Thanks.

[Terry]

I find the U.S. attitude to small business and self sufficiency laudable at times..but also scary too, particularly if you are weak.

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