The War on Small Business

Today, we revisit a recurring theme: the assault on enterprise. It was the subject of our symposium in Vancouver in July. In this episode, we look at a particularly vulnerable segment of the economy: small businesses.

To help set the stage, let’s look at some important stats from the Small Business Administration (SBA). Small businesses:

• Represent 99.7% of all employer[s]
• Employ just over half of all private-sector employees
• Pay 44% of total U.S. private payroll
• Have generated 64% of net new jobs over the past 15 years
• Create more than half of the nonfarm private gross domestic product (GDP)
• Hire 40% of high-tech workers (such as scientists, engineers and computer programmers)
• Are 52% home-based and 2% franchises
• Made up 97.3% of all identified exporters and produced 30.2% of the known export value in FY 2007.
• Small firms produce 13 times more patents per employee than large patenting firms; these patents are twice as likely as large-firm patents to be among the 1% most cited.

Further, if you look to the Kauffman Foundation, startup firms are the “sole engine” of job creation in the U.S. economy.

Kauffman crunched a data set from the Census Bureau covering the years 1977-2005. In all but seven years during that period, existing businesses cut an average 1 million jobs… while firms in existence for a year or less created 3 million.

“Policymakers tend to focus on changes in the national or state unemployment rate, or on layoffs by existing companies,” explains Kauffman VP of Research and Policy Robert Litan. “But the data from this report suggest that growth would be best boosted by supporting startup firms.”

Instead, these small firms are being strangled. Let us count the ways…

According to the National Business Group on Health, the typical large business will see its health insurance costs rise 9% next year.

But for small businesses, the numbers are rising faster. Small employers in California are looking at increases of 12-23%, on average, according to The Los Angeles Times — one got notice of a 76% increase.

It’s an acceleration of a long-standing trend…

The government has skewed health insurance costs in favor of larger businesses for decades… and now the “health reform” law signed this year is tilting the scales that much further.

Then there’s this nugget tucked into that other legislative monstrosity known as “financial reform”: Starting in 2012, every business must issue a Form 1099 to every vendor from whom it buys more than $600 in goods or services every year.

So if you’re a small businessperson and you order $601 in office supplies from Staples over the course of a year (better keep a running total), you must issue a 1099 to Staples.

26 million sole proprietorships alone will be caught up in this net. SMC Business Councils, a business networking group, reckons its typical member currently files about 10 1099s a year. Under the new rules, SMC estimates the number could reach 200.

The idea behind this requirement is to increase compliance with existing tax law. The unintended consequence is it will bury small businesses in paperwork.

Very small firms with fewer than 20 employees already spend 45% more per employee than larger firms to comply with federal regulations, according to the SBA.

And yet… right on cue… a study released by the pithily named Transactional Records Access Clearinghouse at Syracuse University shows the IRS has increased its audit hours of small businesses (those with less than $10 million in assets) by 30% over the last five years.

At the same time, large corporations’ audit hours are down 33%.

The average amount of “underreporting” found for each audit hour of a small- or midsized business was $1,025. For a large corporation, it was $9,354.

Hmmmn… that’s a good trend if you’re a lawyer at a Fortune 500 firm. It’s bad if you’re trying to book a tee time or grow a small business.

Individual sectors are also getting hit hard…

• The financial reform law is hitting small community banks with big regulatory hurdles. “We will no longer be able to evaluate loan applications based solely on the creditworthiness of the borrower,” complains Sarah Wallace, chairwoman of a small thrift in Ohio, in The Wall Street Journal. “We will be making regulation compliance decisions, instead of credit decisions”

• The requirements buried in a “food safety” bill likely to pass Congress this month will have a devastating impact on small farmers. “This could make farmers markets go away,” farmer Scott Frost tells the Portland Oregonian. “The only guys left standing in the room will be the big gorillas.” That’s because the big boys can easily absorb the record-keeping requirements (and annual fees) that come with the bill.

It’s not just the Feds looking for a piece of these guys. Small businesses are looking juicy to revenue-starved state governments. To wit…

• Pennsylvania is looking to add a 6% sales tax to plumbing and electrical services
• Wristwatch repair may become subject to a 4% sales tax in New York
• Four states are looking to join the 26 that already tack on a tax or fee at bowling alleys
• Want to go horseback riding in Arizona? The stable owner may soon have to charge you a 5.6% sales tax
• Three states may opt to start taxing interior decorating services.

Given the environment, this next nugget should come as no surprise.

The National Federation of Independent Business puts out a monthly “Optimism Index” of small-business owners it surveys. Last month, that number sat at 88.1. The last time the number stayed above 90 for longer than three months was early 2008. It was over 100 as recently as October 2006.

“The persistence of Index readings below 90 is unprecedented in survey history,” says the NFIB. Contrast its readings over the last five years with, for instance, the big-business ISM manufacturing index, which has pointed to expansion for over a year now…

“It seems,” Barron’s columnist Randall Forsyth writes archly, “America’s entrepreneurs were too busy struggling with their own businesses to read all the accounts in the media about how terrifically the economy is doing.”

When NFIB survey participants were asked what is the single-most-important problem facing their business, a plurality of 29% said “poor sales.” But right behind that…

• 22% cited taxes
• 15% cited “government regulations and red tape”
• 7% cited “cost and availability of insurance” — as we’ve seen, a government-created problem.

Only 4% cited availability of credit. Good thing we spent billions in bank bailouts to keep the lines of credit open, isn’t it?

Addison Wiggin
for The Daily Reckoning