Putting the Spotlight on Small Business

In March 2002, President Bush argued for steep tax cuts as a stimulus for small business growth. Speaking before the Women's Entrepreneurship Summit, the president said: "It's really important for people to understand, as we're fighting a recession, if small businesses create two-thirds of the new jobs, it makes sense that any economic recovery strategy focus on small business." Unfortunately, the Bush administration has chosen failed policy directions to address the structural challenges that small businesses face. The administration has peddled tax cuts for large corporations and wealthy mega-millionaires as the cure for all that ails the American economy—and gutted and subverted small business programs at the same time.

• In 2003, 38 states lost more small business employers than they gained, with rates of firm closure higher than the rates of firm birth.
• Small businesses with fewer than 20 employees employed over 20 percent of the labor force in 1988—in 2002, their share was reduced to 18 percent of the labor force.
• In 2002 and 2003, self-employment rates were the lowest in decades. In fact, in 2003, the U.S. self-employment rate was the third-lowest among OECD member nations.
• The volume of commercial loans to small businesses has fallen off sharply—$875 billion in 2004 compared to $1.1 trillion in 2000. And venture capital investment has slowed from an average of $27 billion per quarter in 2000 to $6 billion per quarter by mid-2004. The Bush administration has exacerbated the lack of access to capital by slashing the Small Business Administration (SBA) budget by almost 50 percent since 2001.
• President Bush pays lip service to an "ownership society" but his administration has consistently targeted the SBA's venture capital, micro-lending and loan guarantee programs for women, minorities, and underserved populations for elimination.
• Under President Bush, the SBA has failed to effectively combat widespread fraud and failed to enforce regulations regarding government contracting for small businesses. Internal reports that the SBA was forced in court to make public revealed that over $2 billion in small business contracts, including over $400 million in minority-disadvantaged set-aside funds, went to some of the largest companies in the world, including Hewlett-Packard, Titan Corporation, Raytheon, and Archer Daniels-Midland.

For millions of Americans, starting a business is a means of economic mobility—especially for immigrants. But state and local economies often see the most substantial positive economic effect from small businesses when these businesses are able to branch out and hire employees, thereby creating jobs. The most recent data available reveal that in 2003, 38 states were losing these small businesses faster than they were gaining new ones (Table 1). All 12 states in the Midwest and nearly all of the states in the Northeast census regions had small business termination rates that were higher than the formation rates.

Table 1: Small Business Employer Firm Formation and Termination Rates (%), by State (selected years)

Source: Small Business Administration: Small Business Economic Indicators from data provided by the Bureau of the Census and U.S. Department of Labor: Employment and Training Administration.

Starting in 2001, we see the accelerated erosion of small business participation as employers in the labor market but these trends began before the current business cycle. In 1988, the largest companies in America (those with at least 500 employees) employed 45 percent of the total labor force (Figure 1). In 2002, the employees of these largest firms were a full 50 percent of the labor force (Figure 2). The data reveal that within the broad grouping of small businesses—most frequently defined by the SBA as firms with fewer than 500 employees—the smallest firms suffered the steepest loss of labor market share.

Source: Small Business Economic Indicators, Small Business Administration from the U.S. Department of Labor: Bureau of Labor Statistics

Source: Small Business Economic Indicators, Small Business Administration from the U.S. Department of Labor: Bureau of Labor Statistics

The entrepreneur has a firm footing in American culture but a much weaker hold in the American economy. The self-employment rate has been falling since the mid-1990s (Figure 3). In 2002 and 2003, the self-employment rates were the lowest on record.

Source: Small Business Economic Indicators, Small Business Administration from the U.S. Department of Labor: Bureau of Labor Statistics. Self-employment (unincorporated, primary occupation) is based on the civilian labor force.

And the international comparison is unfavorable: The Organization for Economic Co-Operation and Development (OECD) shows that among member nations, the United States had the third-lowest self-employment rate in 2003, the most recent year for which data is available (Figure 4). While a large agricultural sector understandably boosts a nation's self-employment rate, this alone cannot account for the disparities between the United States and other wealthy and highly industrialized nations.

Source: OECD Labour Force Statistics, Factbook 2005

During the current business cycle, small businesses have faced difficulties securing loans. The volume of commercial loans to small businesses has fallen off sharply—$875 billion in 2004 compared to $1.1 trillion in 2000. Meanwhile, the pace of venture capital investment has slowed from an average of $27 billion per quarter in 2000 to a mere $6 billion per quarter by mid-2004. Between 2000 and 2003, capital expenditures by non-farm non-financial corporate businesses were down 14 percent—from $926.7 billion to $796.9 billion. Over the same period, financial assets of these businesses dropped 50 percent, from $1.2 trillion to $605 billion.

Without access to affordable credit, entrepreneurs are often forced to borrow not as small business owners but as home owners. Increasingly, entrepreneurs find that a second mortgage on their home is the most pragmatic course of action. Between 1990 and 2001, mortgages declined as a share of the total liabilities of non-farm non-corporate businesses (Figure 5). This trend reversed in 2001, however, with mortgages now increasing as a share of liabilities.

Source: Federal Reserve, Flow of Funds Accounts, L.103 Nonfarm Noncorporate Business

Unfortunately, the Bush administration's economic philosophy too often supports big business and existing capital, instead of focusing on the innovative capacity of small businesses and their ability to create new capital. The actions of the SBA, a blend of policies that are hostile to small businesses and a lack of will to enforce policies that support small businesses, suggest that President Bush's SBA has operated as simply more of the same big business giveaways. And this time, middle-class entrepreneurs have to foot the bill.

Hostile Policies

SBA Funding

Since 2001, the SBA's budget has been cut from $900 million to $593 million. President Bush's FY2006 budget proposal stands in sharp contrast to the president's comments on small businesses throughout 2004. The administration proposed:

• To eliminate funding for the 7(a) loan program which offers partial guarantees on loans to small businesses, increasing lender fees as a result.
• To eliminate the Program for Investment in Microentrepreneurs (PRIME) which provides in-depth business counseling to low-income entrepreneurs.
• To eliminate the Microloan program which provides access to credit for a largely underserved population—30 to 40 percent are rural, nearly 40 percent are women, 30 percent are African American and 11 percent are Hispanic=
• To eliminate the Small Business Investment Company (SBIC), a program that accounts for roughly half of all venture capital deals in the U.S., providing $1.5 billion in venture capital to small businesses in 2004.
• To cut Women's Business Centers (WBCs) grants by half, resulting in at least 50,000 business owners losing support.
• To cut 20 percent from the SBA's Native American outreach assistance.
• To cut $1 million from Small Business Development Centers (SBDCs).
• To zero-out funding for the BusinessLINC program, Business Information Centers (BICs), the Federal and State Technology (FAST) program, the New Market Venture Capital (NMVC) program, the Rural Outreach Program (ROP), and the Small Business Innovation Research (SBIR) program.

Unfair Competitive Structure

Current SBA policies appear designed to broaden the net far beyond the population of small businesses. The SBA defines a small business as a business with fewer than 500 employees, although 98 percent of businesses have fewer than 100 employees and 89 percent have fewer than 20 employees. A recommendation to return the basic employee limit to 100 was halted by the SBA in July 2004 because this rule would have disqualified more than 34,000 firms currently recognized as small businesses. To this absurdly broad definition of "small business," the SBA has tacked on a grandfather policy that allows a small business acquired by a large business to continue to claim its small business status for up to 20 years.

The U.S. federal government is the single largest buyer of goods and services in the world, with more than $200 billion in annual purchases. The SBA's own analysis cites the federal government's failure to ensure open competition for small businesses—with a cost of $900 million in missed contracting opportunities in 2002 and an estimated $1 billion in 2003.[1] Additionally, the practice of "contract bundling" generates mega-contracts which are too large for small businesses to bid on or participate in as prime contractors. Unfortunately, the SBA has failed to aggressively make use of its ability to appeal these decisions.

And even though Congress passed legislation mandating that all federal acquisitions between $25,000 and $100,000 be set aside for small businesses, the SBA and the Office of Management and Budget (OMB) have exempted GSA schedule acquisitions—99 percent of the government's purchases—from this mandatory set-aside.

Policy Violations

Under the current administration, the SBA has overseen the transfer of billions of dollars earmarked for small businesses to global corporations—transfers that are fraudulent even under the SBA's increasingly lax standards. A May 2005 report by the New Mexico Business Weekly found that:

"In recent years, billions of dollars in federal contracts that various government agencies claimed were awarded to small businesses actually went to big companies like Titan Corp., Raytheon Co., General Dynamics Corp., Booz Allen Hamilton Inc., Archer Daniels-Midland, and Hewlett-Packard Co. Even the SBA has been caught awarding small business contracts to large companies."

The claims of the small business community find support in the audit reports commissioned by the SBA's Office of Advocacy. In FY2002, 44 large firms including Raytheon, Northrop Grumman, Hewlett-Packard, Archer-Daniels Midland, and General Dynamics received over $2 billion in small business contracts—$464.5 million of which was in 8(a) minority-disadvantaged set-aside funds, according to one SBA-commissioned report.

A February 2005 report by the SBA's Office of the Inspector General slammed the government's small business contracting system and called the FY 2003 figures into question. A second report faulted the SBA for awarding four of its six high-dollar "small business" procurements to large businesses over a nine-month period between October 2001 and June 2002. The report explicitly states, "in all four of these cases, we found no evidence that SBA attempted to obtain current size information."

The American Small Business League claims that "not one company has been prosecuted or penalized in any way for misrepresenting themselves as a small business"—a claim substantiated by the Inspector General's office. With companies like AT&T Wireless Services, Office Depot, Northrop Grumman Space & Mission Systems Corp., and Boise Cascade qualifying as small businesses as recently as 2003, the administration's unwillingness to prosecute these misrepresentations—"federal law provides for fines of up to $500,000 and prison terms of up to 10 years"—reflects the broader pattern of lax regulation on big business. As an advocate for small businesses, the SBA has nonetheless refused to routinely publish a list of businesses found ineligible and remains unwilling to notify all government agencies of their status.

Unfortunately, every dollar that these big businesses take is a dollar taken from small businesses and an American taxpayer's dollar wasted.

In an increasingly global economy, America's small business owners face incredible challenges. In cities and towns across America, entrepreneurs are struggling to remain competitive—as employers and as producers. Unfortunately, the Bush administration has pursued policy choices that have had the effect of a full-frontal assault on the existence of true small businesses and has put in jeopardy the historic role of small businesses as powerful engines of economic growth for the American economy.

Bush, George. "President Unveils Small Business Plan at Women's Entrepreneurship Summit." http://www.whitehouse.gov/news/releases/2002/03/
20020319-2.html

Chapman, Lloyd. "Small Business Administration Refuses to Release Report Concerning Billions in Fraud and Abuse." American Small Business League. Oct. 21, 2004. http://www.emediawire.com/releases/2004/10/emw170718.htm

Chapman, Lloyd. "Buried Report Proves SBA Knew About Fraud." American Small Business League. June 6, 2005. http://biz.yahoo.com/prnews/050606/phm048.html?.v=11

Domrzalski, Dennis. "Federal Contracts Bypass Small Biz." New Mexico Business Weekly. May 6, 2005.

Federal Reserve, Flow of Funds Accounts.

House Small Business Committee Democratic Staff. "Impact of FY 2006 Budget on Small Business." Feb. 16, 2005.

House Small Business Committee Democratic Staff. "108th Congress-Small Business Record." Oct. 2004.

Krachman, Al. "Small Business Act Certification Fraud: Raising the Stakes." Contract Management. June 2005.

OECD Labour Force Statistics, Factbook 2005.

Small Business Administration Office of Advocacy. Small Business Economic Indicators (1994-2003). Washington, DC

Small Business Administration Office of Inspector General. Report Number 5-14. "SBA Small Business Procurement Awards Are Not Always Going to Small Businesses." Feb. 24, 2005.

Small Business Administration Office of Inspector General. Report Number 5-15. "Large Businesses Receive Small Business Awards." Feb. 24, 2005.

Small Business Administration Office of Inspector General. Report Number 5-16. "Review of Selected Small Business Procurements." Mar. 8, 2005.

U.S. Senate Committee on Small Business and Entrepreneurship. "Kerry, Snowe Reverse Bush Cuts and Restore Small Business Assistance." Mar. 18, 2005.

Wyss, Jim. "Small Businesses Seek Fair Fight for Contracts." The Miami Herald. June 9, 2005.