First, a simple fact: according to the Small Business Administration firms with less than 500 employees created 64 percent of all new jobs in the U.S. during the fifteen years up to 2008, and employ over half of all private sector employees in the country. So, naturally, when Washington looks to allocate bailout and stimulus funding, the largess goes straight to bloated, uncompetitive layoff champs like General Motors.
So here’s a crazy thought: how about a little help for folks who actually have some idea how to employ people and make a profit doing it? The potential bang for the buck would be considerably higher in aiding small, innovative firms, or at least in getting out of their way. To do so, however, one has to craft solutions that acknowledge the special problems small firms have in this economy. Here are three approaches:
1) Cut small business payroll taxes. Tax cuts are part of the answer, but recognize that the recent downturn has sharply reduced or eliminated profits for many small businesses, and that early-stage firms usually operate at a loss or “burn rate” even in the best of economic conditions. (Note this last point is also true for older small firms reinventing themselves – a critical ability in an era of both innovation and financial stress – which is why focusing only on new firms would be a mistake). What this means is that while an income tax break for small business is certainly advisable, it will be of limited short term help to firms with little or no current taxable income. This is even more true for the administration’s proposed capital gains cuts for small companies, since such firms rarely have earnings in this form. If we want to help small business, a reduction or moratorium on the payroll taxes small business must pay regardless of profitability is probably the surest way to quickly aid struggling yet promising firms. Because the first priority should be to prevent layoffs and allow retention of the people needed to expand the enterprise and set the stage for future hiring, this cut should apply to the current payroll, not just the new employees the Senate jobs bill targets for tax credits.
2) Provide seed grants for small business in hard-hit urban centers. Cities are natural incubators for small business, providing extensive infrastructure and facilitating networking with an energy efficiency far higher than most suburban or rural locations. But these also tend to be high local tax and cost of living environments, partly because of their disproportionate role in addressing national social issues. In an anemic economy this higher cost structure can drive struggling firms out of town or out of business before they get strong enough to help sustain the city – for example, consider the demise of New York’s Silicon Alley. Federal “urban angel grants” could be used to counterbalance this effect, especially in formerly expanding new business districts that have recently fallen into decline.
3) Encourage venture capital. Access to capital is also critical for small business, and especially for start-ups. Surveys have shown that lack of bank loan availability, while an issue for such firms, is not at the top of their list of current problems. This is partly due to the fact that, with demand for their products and services having fallen so sharply, funding expansion is less of a priority. However, for early stage companies, debt is not the dominant means of financing. In fact, most early stage venture capital is provided in the form of equity, especially convertible preferred (this is a point a few of my economist friends will recall I demonstrated in a paper attributing the phenomenon to problems with debt’s foreclosure option under high probability of “asymmetric information” i.e when entrepreneurs are more likely to know more about the condition of their start-up than venture capitalists). Because this type of funding plays so key a role in backing new and innovative firms, venture capital financing needs to be encouraged right now, and care must be taken to make sure any new taxes and rules do nothing to harm venture capital formation. This means exempting venture capital investments from any coming increases in long term capital gains rates (indeed, cutting this rate would help) as well as from costly regulation contemplated for other financial activities (VC firms had nothing to do with the current crisis and what limited hedging they may do in the securities markets constitutes little systemic risk).
One might reasonably and even urgently ask where the money to do any of this would come from. The answer is from reallocation of some of the funds in the stimulus plan, much of which is slated to be spent sub-optimally. Alternatively, some of the unexpectedly high returns on TARP funds paid back by large banks might be used. Of course, there would be some merit in using these funds to simply reduce the deficit, but if the political winds cannot be prevented from blowing money off Capital Hill, at least let those gusts help fill the sails of a vessel of hope for real job creation. The name of that ship is small business.