When Republicans aren’t busy genuflecting to plaster busts of Ronald Reagan or making Faustian bargains with Grover Norquist, they’re typically falling over each other to praise small business owners, who would obviously be creating jobs left and right if not for the onerous weight of big-government regulation.
Finally, thanks to a new studyfrom the University of Chicago (download the PDF here), the conservative version of reality is being challenged.
This isn’t the first time the GOP’s hagiographic characterization of small business people as noble and patriotic — yet also put-upon and overtaxed — entrepreneurs has been called into question. After prominent Republicans complained that higher taxes on income over $200,000 would hit proprietors who report their business income on personal tax returns, the Tax Policy Center pointed out that only 2.5 percent of business owners make enough to be affected. That raises the question: who are the rest of these people? And, if they’re making less than 200k a year, how many jobs are they really responsible for creating? In fact, according to the Tax Policy Center, “the average positive business income reported on 1040s is less than $40,000.” This reflects not only the fact that most small businesses are not rolling in profits but the fact that many people reporting business income aren’t traditional businesspeople at all. They may run a side business in addition to a day job, the TPC suggests, or receive income from a rental property.
A study published in August by Erik Hurst and Benjamin Wild Pugsley of the University of Chicago has received a lot of attention in the past week, prompting articles in Slate and Businessweek. The authors question the pervasive myth that small businesses drive substantial job creation and innovation. “The idea of small businesses as indispensable to the national welfare dates to Thomas Jefferson’s veneration of the yeoman farmer,” Charles Kenny writes in Businessweek. “Yet the notion that small business is the force behind prosperity is not true.”
It’s a notion that has become gospel for politicians on the left and the right. When President Obama told Congress that “everyone here knows that small businesses are where most new jobs begin,” no one raised an eyebrow. Everyone “knows” that small businesses create jobs, just as everyone “knows” that Saddam Hussein was behind 9/11 and everyone “knows” that one-quarter of the federal budget goes to foreign aid. Many policies are designed to promote smaller companies at the expense of larger ones; the Chicago study enumerates only a handful — and manages to use the phrase “small business” a staggering six times in one sentence:
Within the United States, for example, small business subsidies include providing subsidized or guaranteed loans to small businesses, providing small businesses with access to special lending programs, exempting small businesses from various regulations, providing small businesses preferential treatment when awarding government contracts, and providing small businesses with preferential treatment through the tax code.
Democrats and Republicans alike assume such special treatment is warranted, but Hurst and Pugsley caution that, “[w]hile policy makers and researchers often invoke the potential benefits of small business subsidies, very few discuss the costs.” If fostering job creation is the goal, tax dollars spent to prop up small businesses may be better used to reward employers of any size who actually add jobs or make innovations. When it comes to raising taxes, what Speaker John Boehner calls “job-killing small business tax hikes” may not kill so many jobs after all. Even if one ignores the fact that the increases proposed by Obama would exempt 97.5 percent of small business owners, Boehner’s underlying assumption — that a tax hike on small businesses would hurt job creation, because small businesses create lots of jobs — is incorrect.
Hurst and Pugsley’s study makes for interesting — and, if you skip over the statistics mumbo jumbo, surprisingly lucid — reading. Small businesses, the paper claims, create few jobs because they are unlikely to expand. “Only a small portion of small firms add more than ten employees over the life of their business,” the authors write. This is mostly due to the type of industries in which small firms are concentrated. As Hurst and Pugsley report, “Many small businesses are dentists, plumbers, real estate and insurance agents, small shop keepers, and beauticians.” Ignoring for a moment the fact that a dentist is a person, not a business (despite what the Supreme Court says about corporate personhood), none of these professions lend themselves to vast expansion. Most are based on the skills of a single person. For a plumber whose company consists of a truck with “Rob’s Rooting” on the side, there isn’t a great need to hire new workers. Businessweek points out that, unlike such industries as manufacturing, in which more factory workers mean faster production and increased profits, “these aren’t sectors of the economy where product costs drop a lot as the firm grows.” Indeed, “eighty percent of U.S. small companies that remained in business from 2000 to 2003 . . . didn’t add a single employee.”
The Chicago study suggests that this is precisely what the typical small business owner intended. Most of these people start companies for what Hurst and Pugsley refer to as “non-pecuniary reasons”: the desire for independence, flexibility and control over the future. These are precisely the rewards of small business ownership that diminish as a company grows and turns the owner into a manager or CEO.
Contrary to the fable of the small business owner as a backyard tinkerer, rolling out the next Twitter or Snuggie from a workshop in the garage, few small businesses are particularly innovative. “[M]ore often than not,” Hurst and Pugsley write, the small companies they surveyed “provide a standardized service (e.g., plumbing) to existing local customers . . . Fewer than 20 percent of respondents reported that no one other business was provided their expected product or service to their expected customer base.” This is not a knock against small business people — after all, patent applications are not the mark of a good hairdresser — but rather an acknowledgement that ninety percent of innovation occurs in a narrow slice of the business world.
Businessweek and Slate both latch onto the policy prescriptions with which Hurst and Pugsley conclude their study. There are plenty of reasons government might want to subsidize small businesses, from encouraging self-sufficiency to continuing the so-called “American entrepreneurial narrative,” but if the goal is to drive job creation and spark innovation, “our findings suggest caution when supporting businesses purely by size.” Slate suggests that, instead of throwing tax breaks at every business with fewer than 20 employees, the government “need[s] to focus on the minority of entrepreneurial and growing small firms, as opposed to small firms, full stop.” Tax breaks for companies that receive venture capital funding would steer government money toward businesses already deemed innovative by the private market, and making benefits contingent on actually hiring workers would ensure support of job creators. Quoting from the study, Slate notes that subsidies are often aimed at “increasing innovative risk taking and overcoming financing constraints,” when “these targets are better reached through lowering the costs of expansion, so they are taken up by the much smaller share of small businesses aspiring to grow and innovate.” Though Slate calls this an “admittedly obvious takeaway,” it is nevertheless good advice.
Businessweek more directly tackles the Republican assertion that raising taxes on high earners suppresses job creation. After a quick sop to the Wal-Marts and General Electrics of the world — the author warns that “blanket animosity toward ‘corporate welfare'” discriminates against the large companies that do most of the hiring — Businessweek asks “whether, at a time when Congress is trying to reduce the deficit by $1.5 trillion, it’s worth preserving a general tax cut for those earning over $200,000 merely because it affects some small business owners.” The author suggests that “perhaps we could better use those resources to inject capital in companies that do have a chance to grow.”
The conclusions reached by the Chicago study run counter to the narrative preferred by many politicians, who can never get enough photo ops at clean-energy startups and who run for cover whenever the Chamber of Commerce howls about tax hikes. It’s worth considering, though, how many new employees that tax break to a lawyer or plumber is really going to fund. The Businessweek article ends with a cliché, but the author has a point: “When it comes to creating jobs, size still matters.”