The Small-Business Dilemma
Looming tax increases and a stuck-on-zero interest rate are stopping entrepreneurs from hiring and taking risks.


David Malpass

The economy has strengthened some in recent months — helped by inventory building and excess monetary stimulus from the Federal Reserve — while payroll employment is finally stabilizing. But the economic forces that are working in favor of GDP growth in the short term are not creating a longer-term reason for businesses — small firms, in particular — to invest and hire.

The problems facing small businesses remain immense, as evidenced by the job-loss data. The Labor Department’s household survey, which includes small businesses and picks up inflection points better than the payroll survey, found 589,000 job losses in December and still is not showing the improvement needed to signal a sustainable recovery.

An important new survey from the National Federation of Independent Businesses adds to these troubling statistics.

According to the NFIB survey for December, net changes in employment over the last three months stayed at minus-12 percent, with only 10 percent of business owners adding jobs and a full 22 percent cutting them. Looking forward, net hiring plans for the next three months come in at a seasonally adjusted minus-2 percent, up only one point from the November figure. And job openings notched up only two points in the survey, to 10 percent from the historic low of 8 percent, where the level had sat for the previous four months.

It thus comes as little surprise that small-business optimism has slipped back toward gloomy. The NFIB survey’s optimism index for December fell to 88.0 from 88.3, a setback from the general trend of improvement engaged when the index reached a cyclical low of 81.0 in March 2009.

In the NFIB survey, small companies were asked: “What is the single most important problem facing your business today?” Poor sales ranked first, at an all-time high of 34 percent. Why? A key factor could be the recent rise in government requirements, regulations, and red tape. An increased regulatory burden alters the economic environment, distracting small businesses from their core mission of sales and service.

The second biggest problem facing businesses today? Taxes, which placed second in the NFIB survey at 20 percent.

The fortunes of small businesses — perhaps more than any other commercial sector — are tied to rates of taxation on the individual. And individual income-tax rates are set to jump sharply at year-end when the Bush tax cuts of 2003 expire. Put another way, on January 1, 2011, the world’s biggest tax increase ever will arrive on the doorsteps of U.S. small businesses (and a great many others). Higher tax rates on incomes — along with capital gains and dividends — will reduce the incentive, on the margin, for entrepreneurs to engage in the kind of risks that lead to business formation, economic growth, and job creation.

There’s a monetary component to the small-business nightmare, as well — namely, the Fed’s ongoing near-zero-interest-rate policy.