Extend the Recovery to Small Business

The National Bureau of Economic Research announced last month that the Great Recession ended in June 2009. According to the experts who date the business cycle, the economy has been improving for the past 15 months. If you're one of the small business owners not experiencing the recovery, you're not alone. Plenty of recent data, from opinion surveys to Bureau of Labor Statistics self-employment numbers to the National Association of Credit Management's Credit Managers' Index of bankruptcy filings, indicate that conditions have gotten worse for small businesses since the economic recovery began.

As long as we face declining home prices, uncertainty about the effects of the new health-care law and business regulation, and high and rising marginal income tax rates, the small business sector is unlikely to show the positive owner outlook, job growth, investment levels, and business formation rates common in economic expansions. What will it take to get such a recovery going? We need to fix the weak housing market (not going to happen overnight, I know), reduce uncertainty about new regulation from Washington (ditto), and extend the Bush Administration's tax cuts (ditto again). Dig into these three issues, though, and you'll see why they're so important to resolve.

The weak housing market is weighing down many small businesses. The construction and real estate industries that have been hard-hit by the collapse in home prices are made up largely of small companies. Estimates by Small Business Administration economists indicate that more than 99.6 percent of companies in real estate and construction are small businesses. And unemployment in the construction industry is 17.2 percent.

In addition, small business owners were among the most frequent users of home equity loans during the real estate boom, tapping equity in their homes to fund their businesses. Data from Barlow Research's quarterly survey of roughly 900 small business owners show that 25.4 percent of respondents used their homes as collateral for their businesses or to obtain a personal loan where the proceeds were used to finance a small business. These loans have largely evaporated as housing prices have fallen 28 percent from their peak in March 2006, taking with them much of the home equity that small business owners were using to fund their companies. Combined with tightening loan standards at banks with many nonperforming real estate loans, declining home values have choked off a major source of small business finance, making it difficult for many small businesses to expand.

Health-Care Uncertainty

A lot of small business owners are unsure of the cost and difficulty of complying with the new health-care law.Health insurance premiums are rising in spite of, or because of, the new law.In response, many small business owners, already under pressure from declining sales and profits because of the weak recovery, are spending time trying to adjust their health insurance plans to adhere to the new regulations, while holding down their share of costs.Even the non-health insurance parts of the new health insurance law have small business owners worried.Take, for example, the new rules on 1099 forms. The business owners have no idea how much it will cost them to produce such forms for every vendor they pay over $600—but they know it will be a lot.

Small business owners are worried about what new regulations will be imposed on them as Washington policymakers push for greater oversight of business. A highly regulated environment frightens many business owners because small businesses bear a disproportionately high cost of adhering to the government's rules. As a recent study conducted for the Small Business Administration by two Lafayette University economists, Nicole and Mark Crain, explained: "As of 2008, small businesses face an annual regulatory cost of $10,585 per employee, which is 36 percent higher than the regulatory cost facing large firms (defined as firms with 500 or more employees)."

High and rising personal income taxes are discouraging many small business owners from expanding. Because owners of sole proprietorships or subchapter S corporations pay personal income taxes on their business profits, marginal income tax rates affect their owners' business decisions. Research by Robert Carroll, Douglas Holtz-Eakin, Harvey Rosen, and Mark Rider shows that increases in these taxes inhibit small business hiring and investment. Because a small percentage of highly profitable companies account for much of the hiring and investment by small businesses, the prospect of big tax increases on the owners of these companies has many of them investing and hiring less than they otherwise would.

Policy Choice

All of these problems are keeping small business owners in limbo. Before investing and hiring, business owners are waiting to see what the current policy environment is going to cost them, and how much they're going to have left over for expansion.

So what's the answer? Policymakers need to make a choice. One option is to stop believing that we are going to experience a recovery in the small business sector anytime soon, and accept the tepid economic growth we will experience when half of the private sector doesn't recover. The second option is to view public policy from the perspective of the small business owners and enact laws that encourage the small business sector to expand, invest, and hire. That means cutting regulatory and tax burdens and reducing the chronic uncertainty about future laws that make it difficult for small business owners to plan ahead.

While I'm betting on the former, I'm hoping for the latter. There are a record number of entrepreneurs running for Congress this year. That hints at the potential for new thinking about small business in Washington.

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