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Startups and small business create most new jobs

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Citigroup CEO's Vikram Pandit was fired on October 16, 2012 after five years and compensation of $261 million for his work. Sounds like pay to fail. Mr. Pandit became CEO of Citigroup in 2008 when Citigroup bought Mr. Pandit's Old Lane Partners LP hedge fund a year earlier. Then Citigroup shut down the hedge fund at a write-down of $202 million. Moreover, while Mr. Pandit was at the helm of Citigroup, the company's shareholders didn't do so well: the value of their holdings declined by 88 percent. Who would not like a job where not matter what happens you get paid? If the company makes money and stockholders get their dividends you get paid. And if the company loses money and share value declines almost ninety percent you still get a hefty payday. However, this reality exists mainly in the rarified world of the so-called job creators--i.e. one-percenters. We love the one-percenters. We aspire to be like them--the mansions, the fancy cars, yachts, and Learjet. We loved Dallas. It gave us a glimpse at opulence up close and personal on TV screens in our living rooms.  We loved JR because he was rich, and despite of the fact that he presided over a dysfunctional family. We love CEOs, too. And in the stratosphere of the CEO's world failure is rewarded handsomely.

You Joe Blow are not a job creator. You get fired when you screw up. And taxpayers pick up the tab as unemployment compensation. Taxpayers pay unemployment compensation to workers for a specified number of weeks. When that time period is satisfied some members of Congress say that's enough--even in a recession--for we don't want to encourage idleness and dependency. If you don't find another job during this time period, you're screwed. You can't make your mortgage payments, buy the groceries, make tuition payments for the kids; and without insurance you go to the emergency room when you're sick. Some job creators talk loosely about harvesting businesses, from "rescuing' flailing companies, at no cost to their stockholder. They destroy American jobs and send them overseas. We like these people. We vote for them. We forgive their trespasses. We treat a shoplifter more harshly than we treat them. We bail them out with tax dollars when they abuse their stockholders' trust--all because we admire them and want to be like them. Contrast that with our regard (perhaps disregard) for workers: does lazy or greedy come to mind? The meme on unions is they're bad! Worker strikes and minimum wage legislations are unwelcomed. Who speaks for workers Fox, NBC, ABC, and CBS? Hardly! But these major news organizations, including CNBC, the WSJ, The Financial Times, and Businessweek are voices for Wall Street.

Small businesses have 20 to 99 employees; mid-sized businesses consist of 100 to 499 employees; and large businesses have at least 500 employees or more. A number of research studies argue that there is an inverse relationship between business size and job creation. For example, David Birch (1987) in "Job Creation in America: How Our Smallest Companies Put the Most People to Work," published in Free Press, New York, makes the case that small business creates more jobs. This finding was corroborated more recently by David Neumark, et. al. in "Do Small Businesses Create More Jobs? New Evidence from the National Establishment Time Series," (NBER, February 2008). 

However, in other ways there are real differences between small and large businesses. Large businesses offer more job security, insurance, and other benefits to their workers; small businesses, especially the startups, are ephemeral: most die in a year. But that misses the point, which is small business is the engine of job creation. The only way small business can play this important role in the American economy is if the destruction and creation process of jobs is at minimum equal; or preferably net job creation is positive. For an analogy imagine a coal-fired furnace. To make it generate heat, you stoke it with coal. Of course, heat production destroys coal; so you need to add more coal to the furnace again and again. The point is small business generates over 79 percent of new jobs added to the economy, but some die in one year. That is, behind the scenes as one business is lost another startup takes its place; when that one dies, another steps in and takes it place. This is a dynamic process in the economy that economists refer to as frictional unemployment.

Big business hires many workers. Sears has 300,000 and Apple has 35,000 employees. Big business accounts for approximately 50 percent of all jobs. But unless they expand and innovate, the number of employees they have won't change much. On the other hand, small businesses contribute to 50 percent of GDP. The remaining 50 percent of GDP is divided up between mid-sized and big businesses, which together represent 50 percent of jobs. In a previous post I indicated that higher taxes on the one-percenters will not reduce consumption needed to boost the economic recovery. It seems, too, that differential tax treatments favoring small business have positive effects on the economy.  There have been a number of "tax breaks" the Obama administration extended to small business. Two are particularly important: the Health care tax credit, which was enacted with the 2010 Affordable Care Act (ACA), for small businesses that provide health care insurance to workers. The ACA needs to be both understood better and widely embraced. Businesses are not taking advantage of the tax breaks because of confusing rules; and they are missing out on billions of dollars in breaks according to the Congressional Budget Office (CBO). The other break is startup deductions. Startups can deduct up to $10,000 of startup costs for such things as marketing research and office supplies. You start up a new business and you get a $10,000 break--that's money in the bank. The deduction is a big incentive! It helps with insuring your workers and reduces your insurance costs. I hypothesize that happy workers are hard workers. Insured workers are happy. Therefore, insured workers are hard workers.

If as some people assert, higher taxes discourage investment and growth, then by that logic tax breaks encourage investment and growth. Now, since startups and small businesses create most of the new jobs in the economy, then it makes sense to provide startups and small businesses with deductions as incentives for new business formation. In a slowly growing economy (registering 2 percent growth), demand is also a problem. Another stimulus could help demand in spite of the fact Republicans say the stimulus did not work--even as some of them like Representative Paul Ryan of Wisconsin, and Gov. Chris Christie of New Jersey took stimulus money, while condemning it. In politics there is a mismatch between what politicians say and what they do. The reelection results may give President Obama more flexibility to enact more business-friendly policies, and enact policies that could produce the 12 million jobs projected for the next four years.

Startup business is the brainchild of an idea--whether it is Facebook or Apple.  Mark Zuckerberg and Steve Jobs (including Ronald Wayne and Steve Wozniak) did not make taxes a barrier to their creativity. Apple almost failed. The company was in decline from the mid-1980s to the 1997, when Steve Jobs returned it to profitability. But its difficulties had nothing to do with taxes, but everything to do with the product and market conditions. In September 2012 at $17.55, Facebook stock was selling much below its IPO price of $38. Now as a stretch, you could say that the poor economy is responsible, and that the government is responsible for the poor economy--not Wall Street of taxes. So, the government is responsible to the poor performance of Facebook stocks. This kind of convoluted thinking comes at everything from a view that government is the source of all things bad. But that's an argument for another time. The fact is startup and small businesses play a major job role in the U.S. economy. When friends say, "I want to run a convenience store, start an import business, open a dance studio, teach online, develop ring tones for cell phones, open a restaurant for exotic foods, start a wholesale outlet for vegetable retailers, etc," I never hear questions about taxes. And I don't see too big to fail big businesses that want the government to leave them alone, until they need to declare bankruptcy. When my friends enter the fray they survive or fail on their own effort--or on whether they made the right choices of location, product(s), and prices (including costs). Their survival rarely has anything to do with taxes (or the government), but everything to do with the degree of effort they bring to their business endeavor. When my friends fail--they are not offered a parachute like the CitiGroup CEO. Yet, my friends are startups and small business--they create jobs often for themselves by providing a service or product that did not exist before.

Distemper is favoring job creators with tax cuts when the empirical evidence says otherwise. In a prior posting, "The Debate on Tax Cuts: More Politics and Economics (see: click here), I argued that top marginal tax cuts did not correlate with economic growth in the American experience. The Congressional Research Service reported the same finding, but had to withdraw their economic report after Senate Republicans raised concerns about it. According to the New York Times, the report was withdrawn because it questioned the central tenet economic theory espoused by conservatives. (see: click here)

We need to stand behind startups and small businesses, which are the engines of job creation. Their viability encourages economic growth. Further, since the evidence that cutting top marginal tax rates to support economic growth is misguided, a preferred policy choice is to reduce the tax burden on startups and small business, and on low- and middle-income taxpayers. 

 

Seymour Patterson received a Ph.D. in economics from the University of Oklahoma in 1980. He has taught courses and done research in international economics and economic development. He has been the recipient of two Fulbright awards--the first in (more...)
 
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Big business rests on pedestals. ... by Seymour Patterson on Friday, Nov 9, 2012 at 12:04:51 PM
And the info about the tax breaks which are not us... by BFalcon on Friday, Nov 9, 2012 at 8:33:05 PM
I agree, but would like to add that worker-owned b... by Sally Stevens on Friday, Nov 9, 2012 at 1:52:38 PM
See Human Investment at http://www.aesopinstitute.... by Mark Goldes on Friday, Nov 9, 2012 at 3:57:41 PM
make sure we haave universal  medical  i... by Mark Sashine on Friday, Nov 9, 2012 at 9:17:36 PM
when the cost of access to a piece of land is so h... by David Chester on Sunday, Nov 11, 2012 at 5:56:08 AM
One of the unintended, but positive, conseque... by Reza varjavand on Monday, Nov 12, 2012 at 5:15:30 PM