Obama's Small-Business Schizophrenia

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WASHINGTON-Even as Congress is moving towards final passage of the Small Business Jobs Act of 2010, giving small businesses special tax breaks and a federal investment fund of $30 billion, President Obama continues to insist on raising income taxes on some small business owners, on more "insourcing" (taking contracts from private firms and giving the work to government employees), and on choking businesses in red tape.

This makes no sense. Why set up programs to favor small business with one hand, while putting up obstacles with the other? Why not just keep taxes at their present levels by making the 2003 tax cuts permanent, abolish insourcing, and cut red tape?

No matter that a new study just out from the National Bureau of Economic Research, by University of Maryland professor John Haltiwanger and Census Bureau economists Ron Jarmin and Javier Miranda, concludes that large firms create as many new jobs as do small firms when the age of the firm is accounted for. If this result is correct-and the empirical evidence is persuasive-then Congress should not favor small firms, but treat all firms equally.

But debating the merits of helping small rather than all business does not concern Congress, whose members face difficult re-election contests this November due to the weak economy.

So the Small Business Jobs Act of 2010 is likely to pass the Senate this week, after Republicans George Voinovich of Ohio and George LeMieux of Florida joined the Democrats Tuesday to block a threatened GOP filibuster. Then it will go to the House, which is expected to whisk it through and send it to Mr. Obama for his signature.

The major component of the proposed bill is a $30 billion second Troubled Asset Relief Program (the 2008-09 loan fund to prop up banks), called the Small Business Lending Fund. It would let the Treasury buy preferred stock and debt instruments from financial institutions with less than $10 billion in assets.

If the financial institution increases its small business lending by 10%, the interest rate it must pay on preferred stock is only 1%. Otherwise, it is 5% for the first two years, then 7% for two-and-a-half years, and 9% thereafter. This makes it only worthwhile for banks to accept such Treasury investments if they plan to ratchet up small business lending.

There are so many problems with this idea that it's hard to know where to start. One is the premise - that the financial institution has a backlog of small - business loan applications that it deems credit-worthy but lacks the money to make the loans.

Then there is a philosophical objection that the government should not be involved in lending to business-that's the purview of banks. If banks aren't lending, Congress should figure out why. Perhaps it's weak loan demand by qualified borrowers, or uncertainty about 2011 tax rates, or the new financial regulation bill, which raised the costs of lending and borrowing.

In addition to this new "TARP 2," the Senate bill seeks to funnel additional capital into small business by more than doubling Small Business Administration loan limits. It also allows more generous investment write-offs, the application of tax credits to prior tax years, and other technical kinds of tax relief.

Congress is enacting a complex set of provisions to help small business. But what one hand giveth, the other taketh away.

Most obviously, there is the risk that a legislative impasse will let the Bush tax cuts expire - and tax rates will rise on all incomes in 2011. Uncertainty hovers, discouraging lending and risk-taking. Although Republicans and some Democrats have come out against the tax increases, Congress has not yet acted to postpone them. Keeping rates permanent would do even more to help small business.

President Obama and some Democrats propose keeping current tax cuts for all except those in the top two tax brackets. These top brackets, falling on taxable incomes of $209,000 a year on joint returns and $171,000 a year on single returns, would hurt small business because many owners file as individuals, not corporations. IRS data show that in 2007, the latest year available, 48% of small business net income can be attributed to households with incomes over $200,000.

Another drag on business: President Obama continues to push for "insourcing," laid out in a March 2009 memorandum seeking to cut back government-funded private sector contracts. This deprives small business of government contracts and raises government costs. Defense Secretary Robert Gates admitted on August 9 that "we weren't seeing the savings we had hoped from insourcing."

Even Senator Robert Menendez of New Jersey and California Senators Barbara Boxer and Dianne Feinstein, Democrat stalwarts, have expressed serious reservations about insourcing on the grounds that it takes away opportunities from small business and raises the cost of government.

In addition, the administration continues to burden small business with ever-more red tape, such as the latest Internal Revenue Service form for calculating the tax credit for small businesses' health insurance premiums, released in draft form on September 7. Unfortunately, after completing the complicated form, found here, small businesses with 25 or more workers will find that their credit equals...zero.

Another example of red tape is the new requirement from the health care law that firms send an IRS Form 1099 to every company from whom they have purchased more than $600worth of goods, with a copy to the IRS. Currently, 1099 forms are sent to individuals who provide services to firms, but not to vendors of goods.

This is not simple. One business might own several firms. So purchases of $250 from three gas stations owned by the same company might initially appear not to require a Form 1099 - whereas the form would be required. Similarly, one firm might own several taxi companies. Business owners would be required to keep track of which companies own which taxis in order to know whether they have exceeded the $600 threshold and need to file a 1099 form.

There are better ways to help small business than the Small Business Jobs Act. Keep taxes low, stop insourcing, and abolish the red tape. That might gain votes in November too.




Diana Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is senior fellow and director of Economics21 at the Manhattan Institute. Follow her on Twitter: @FurchtgottRoth.   

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