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<i>The Week in Public Finance:</i> Are Small Businesses Really the Backbone of the Economy?

Two economists argue that they aren't. Instead, they say, policymakers should focus on larger employers.

(David Kidd)
No matter their politics, there's at least one thing that all elected officials seem to agree on: the idea that small businesses are the backbone of the American economy.

But economist Robert Atkinson says that notion is a myth. Instead of creating policy that gives a leg up to mom and pops, he says, policymakers should focus their attention on businesses that have the potential to scale up into dynamic national or even global firms.

“Why should Ashley and Justin get tax breaks and exemptions from regulations to help realize their dream of opening a brick-oven pizzeria?” asks Atkinson, president of the Information Technology and Innovation Foundation, a think tank in Washington, D.C. “Helping a robotics or biotech firm that can boost national productivity and competitiveness will benefit everyone.”  

Atkinson and economist Michael Lind are authors of the new book Big Is Beautiful: Debunking the Myth of Small Business. It makes the somewhat unpopular argument that small businesses are not the economic engine they’re purported to be largely because they don’t attract new money into a region, and don’t create high-quality jobs.

While nearly half of the private-sector workforce is employed by small businesses, Atkinson says, larger businesses, on average, pay 54 percent higher wages, lay off workers less, are more unionized and offer better benefits.

Atkinson and Lind’s research also indicates that states with a higher share of small businesses tend to have a lower average income. “Having an economy dominated by small firms,” Atkinson says, “is a recipe for a lower per capita income.”

Small business advocates, naturally, find fault with these claims. For starters, they point out, small businesses are still big job creators. According to the Small Business Administration, firms with fewer than 500 employees have accounted for roughly two-thirds of the net new jobs created since the early 2000s. Small businesses also account for 43 percent of the total private-sector payroll.

Meanwhile, a 2015 study from the group Good Jobs First concluded that, far from being favored, small businesses are being shortchanged, at least when it comes to government tax incentives. An analysis of more than 4,200 economic development incentive awards in 14 states found that large companies receive dominant shares: 70 percent of the deals and 90 percent of the dollars. This was true even as the deals, worth more than $3.2 billion, were available to both small and large companies.

Still, the authors aren’t saying that all small businesses should be left to fend for themselves. Rather, public policy should encourage start-ups that have the potential to scale up into larger businesses. According to Atkinson and Lind, that means focusing for the most part on tech start-ups. These firms are typically generators of all kinds of innovation and creativity. A study conducted by the Small Business Administration found that small businesses produced 16 times more patents per employee compared to larger firms.

While public policy like tax or regulatory exemptions for small firms might help keep some businesses afloat, Atkinson says, support for more growth-oriented firms is far more likely to have an economic impact.

For example, Louisiana has a tax credit program to support angel investors and research and development spending. “Those are programs that make a lot of sense because they help the kind of firms that we want to grow and that could create lot of jobs,” Atkinson says.


In other public finance news this week:

Kentucky Avoids a Downgrade

After being threatened with a downgrade, Kentucky has approved a budget that includes funds for its broadband initiative, Kentucky Wired. The public-private partnership project (P3) started in 2015 with the goal of extending high-speed internet across the state. Instead, it has been slowed by delays. Fitch Ratings had warned that a failure by the state to cover the additional payments stemming from those delays could result in a rating downgrade.

While the crisis in Kentucky was avoided, municipal analyst Matt Fabian noted this week the situation could have negative connotations for P3 investors because it suggests such funding “could be subject to a higher level of political risk.” Up until this week, funding for the project was in question as lawmakers in Lexington argued over where the money would come from and whether it was worth it. Therefore, “traditional bonds sold by P3-using states and local governments may be at greater risk of becoming tangled in a negative rating action related to willingness,” he warned.


Meanwhile, Connecticut Gets Downgraded

S&P Ratings slapped Connecticut with a downgrade in part because of added liabilities from its Hartford financial rescue package. In its review, the ratings agency said the state’s $23.6 billion in debt met the agency’s threshold for a downgrade. “While we view Hartford as a unique situation and the city's debt as relatively small in relation to overall state resources, the assumption of debt, combined with other trends, leads us to conclude that Connecticut's debt burden is not likely to shrink in the near term,” S&P’s David Hitchcock said in the news release.

Meanwhile, the agency also awarded a super-upgrade to Hartford, which is handing over much of its debt service to the state in exchange for financial control concessions. S&P upgraded Hartford from junk status to an A rating.

In a response this week, Connecticut State Treasurer Denise Nappier said that the state’s newly enacted debt controls should have been a factor. “That Connecticut's debt is not significantly affected [by rescuing Hartford], coupled with the fact that the state has enacted a cap on rising future debt burden, draws into question the soundness of S&P's rating,” she said.

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Liz Farmer, a former Governing staff writer covering fiscal policy, helps lead the Pew Charitable Trusts’ state fiscal health project’s Fiscal 50 online resource.
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