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'Policy Uncertainty' Constrains Small Business

Politicians have long argued about what the government should do to best help small business owners. Lately this debate has centered on the effect of what many describe as “policy uncertainty,” or the inability of business owners to predict what regulations, taxes, and other policies lawmakers will impose in the future.

Republicans claim that policy uncertainty is keeping small businesses from expanding, dampening job creation and weakening growth in gross domestic product because small companies account for half of private sector economic activity. Unable to predict what future government policies will entail, they explain, small business owners are holding back, avoiding decisions that could prove foolish once future policies are enacted. Democrats counter that there’s no evidence policy uncertainty is responsible for the currently tepid small business sector.

Mark Schweitzer of the Federal Reserve Bank of Cleveland and I looked at the data to see who’s right. In a recent commentary, we examined its effects on small business expansion plans. We compared one set of data on policy uncertainty described in a recent academic paper with another set on hiring and capital investment plans from January 1986 through July 2011 collected in the National Federation of Independent Business’s monthly survey.

A Big Negative Effect

Policy uncertainty and small business expansion plans are tricky things to measure, but we believe economists can draw conclusions about their effects by comparing the two sets of numbers. (Because I don’t have room to explain why in this column, I refer readers to our commentary). While the NFIB surveys only its own members, not a random sample of small business owners, economists have found that its results are generally consistent with what’s happening to small businesses in the U.S.

Controlling for a variety of alternative explanations and using a variety of different measures of policy uncertainty, we found a large and statistically significant negative effect of policy uncertainty on small business hiring and capital expenditure plans over the past 25 years. As Schweitzer and I explain in the commentary, in July of 2011 (when our data stop), the net percentage of small business owners who were planning to hire—those hiring minus those laying people off—would have been 6 percentage points higher had there been no policy uncertainty.

While I acknowledge that there will always be some degree of uncertainty surrounding policy makers’ actions, the implications of our findings are straightforward: If the Obama Administration wants to get small business owners to expand, it needs to stop arguing that policy uncertainty doesn’t matter.  Treasury Secretary Timothy Geithner shouldn’t be telling the Senate, for instance: “I don’t think there’s good evidence in support of the proposition that it’s regulatory burden or uncertainty that’s causing the economy to grow more slowly than any of us would like.” Small companies would expand, creating jobs and boosting GDP, if only Washington were to make future policy plans clearer.

Three Ways to Cut Policy Uncertainty

Let me offer three suggestions on how to do this: First, our elected officials need to stop passing temporary legislation in place of permanent policies because those laws create too much uncertainty for small business owners, who need to forecast future costs and revenues to make decisions. Second, Congress and the President need to stop enacting laws that require months or even years of bureaucratic interpretation before small business owners can figure out what the provisions mean. Third, those in Washington need to refrain from enacting legislation so complex that no one can understand its implications.

While both parties need to work together to reduce policy uncertainty, the first step is for the Democrats to accept that policy uncertainty is real and is holding small businesses back. Then both sides need to abandon the temporary legislation approach that has been in vogue lately. For instance, Congress needs to recognize that both the temporary payroll tax cuts that the President proposed in his jobs bill and the income tax cuts scheduled to expire at the end of 2012 are a problem because they aren’t permanent.

By reducing policy uncertainty, our elected officials can help small business owners expand again, creating jobs and boosting GDP. That seems a small cost to pay to get the economy going again.

Scott Shane is the A. Malachi Mixon III Professor of Entrepreneurial Studies at Case Western Reserve University.

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