Big business gets the apple,
Small business gets the shaft
by Cliff Cobb
Small, independently-owned businesses have received
a raw deal from economic theorists and policy makers for over
a century. Theorists have assumed that there is a level playing
field
between big business and small business and that the gradual
displacement of owner-operated stores by chain stores or larger
businesses is
part of a natural operation of a free market. Policy makers have
reinforced the idea that capitalism favors the growth of big
business by providing various subsidies to big business to make
their idea
a self-fulfilling prophecy.
In fact, small farms and local businesses are often more efficient
on a square-foot basis than larger operations. Although there
are economies of scale (i.e., so
that larger size means lower unit costs), there are also diseconomies of
scale, which cause unit costs to rise with size. The appropriate
size for any given
business is based on a balance between those two forces. There is no magic
formula that reveals the optimal size for every business.
My philosophy is that a free and fair market should indeed
determine which business are most efficient, and the less
efficient ones should go bankrupt.
My thesis
is that policies have consistently favored large businesses over small
ones, , and that the proportion of sales and employment by
small firms would grow
in an economy without those biased policies. I cannot define the term “small” because
it varies with the type of operation. In a retail store, it might be two
or three employees in a thousand square-foot store. In vegetable farming,
it might
be fifteen short-term laborers on ten acres. I won’t
even venture to guess what it might be in various types of
manufacturing.
Some personal experiences
Two personal experiences showed me what the economy looks like
through the eyes of a small business owner. It revealed to me
the ways in which
progressives
and
conservatives have unintentionality conspired to undermine the health
of small business.
In 1988-89, I took over from the owner the management of a small
health food store in a suburb of Los Angeles. I had no idea
in advance how
demanding it would be to run a small store, and I was not involved
in every aspect
of the
business.
I did learn something about the pressures on the owner of a small
business, and the small margins upon which they often operate.
During the time I was managing the store, the city council decided
to subsidize a “whole foods market” as part of an effort to redevelop the downtown
area, about a mile and a half from the store where I worked. Sales dropped, although
not precipitously, as a result of the cheaper prices the new store could offer.
Eventually, the subsidized store went out of business. There simply was not enough
demand to sustain it, even with a boost from the city.
In the early 1990s, I attended the annual meeting
of the California Chamber of Commerce. What I observed helped me
understand why small
business
receives such
poor treatment in the U.S. today, despite all of the lip service
paid to it by both political parties. Big businesses are
well-organized
politically
and
small businesses are not. As a result, the Chamber of Commerce is
dominated by the interests of large firms. As soon as I entered
the registration
area for
the meeting, I was bombarded with information about the need to oppose
a health-care
initiative on the state ballot that would be “bad for business.” What
struck me immediately was that the ballot initiative posed no significant
threat to small businesses. (As I recall, they were explicitly excluded
from the provisions
of the proposed law.) It was purely a concern of large corporations.
In similar fashion, there were panels dealing with tort reform and
environmental regulations,
both of which are major issues for giant corporations, but far from
the daily problems of small business. Noticeably lacking
was any concern about workers
compensation, permits and fees that often bear no relationship to
services, reporting requirements for dozens of laws and a regulatory
environment that functions like
a thousand tiny paper cuts, slowly bleeding a small business to death.
A dirty little secret
Large corporations control the agenda of public debate about
business issues. They are in a better position to do so because
they can afford
to hire
lobbying firms in Washington, D.C. and in state capitals. They
can send representatives
to meetings where important regulatory decisions are made. Around
the country, they control the state Chambers of Commerce and other
business-oriented
groups. Small businesses are left with no choice but to go along
with the
big business
agenda.
In addition to the disproportionate political
power of big business, the press colludes in allowing corporate
giants to set the agenda
for debate.
To the
extent that major newspapers or television networks run business
stories, they deal
with
national legislation that impinges mostly on big business.
I did discover one bit of “intelligence” through
reading, however. A few economists have recognized that seemingly
neutral environmental regulations
are in fact biased in favor of larger firms. A cumbersome set
of regulations actually increases the competitive edge of large
companies because they can spread
the cost of compliance over a larger base of sales. Despite
the complaints of big business about environmental regulations
that interfere with production, the “dirty
little secret” is that big business actually benefits
from those regulations. As they put it, “we can live
with the rules.” What that really means
is that the high fixed costs imposed by complex regulations
and reporting requirements create a barrier to entry to small,
new firms that could lower real costs. Many
federal regulations regarding health, safety, and the environment
have the consequence of creating monopolistic conditions for
big business by blocking competition.
The solution does not lie in eliminating regulation entirely;
it involves recognizing that the precise method of regulation
is important.
The general principle
Although the experience with regulation at the national level
does not apply directly to the problems of small, local businesses,
it is possible
to derive
a general principle that has broad scope: “Any law or regulation that imposes
fixed, up-front costs rather than variable costs that are paid for over time
has the effect of decreasing the competitive position of small business.”
What is crucial about this principle is that it deals with
relative, not absolute costs. Many small business owners,
looking only
at their own books,
complain
about policies that raise their costs. However, if a policy
raises costs in a manner that affects all businesses equally
(a rare
event), then
their competitive
position would remain constant. What is ultimately harmful
to a business is a
rule that helps one business at the expense of others.
A tax that hurts small business
The ways in which state and local regulations impose burdens
on small businesses are generally fairly straight-forward.
A programmatic
approach to dealing
with those burdens would be to evaluate them, determine
which ones are burdensome, and develop strategies for
modifying those regulations.
This
would be a more
effective approach than dealing with them sporadically
and
on a piecemeal
basis.
The choice of taxes (sales, business, property, etc.)
is among the most important ways in which government
imposes
differential
burdens,
helping
one business
at the expense of another. No one ever likes paying
taxes, but the issue for small
businesses is how different taxes affect them in ways
that distort free market choices and consequences.
To understand the impact of taxation on business, it
is necessary to consider the question of location.
Imagine one store at
a busy intersection
and
another at a location with few people passing. Let’s call the first location “central” and
the second location “peripheral.” In general, large businesses control
the best (i.e., central) locations within any metropolitan area. The reasons
are complicated, but they stem from the political connections that help big business
in many other ways. As a result, a tax policy that helps “central” businesses
and hurts “peripheral” businesses is automatically biases against
small owners.
The sales tax is highly destructive of small businesses
in peripheral locations. An example can explain
why. Imagine a business in
a central location.
| Before sales tax |
After sales tax |
| • $2M in annual sales |
• $2M in annual sales |
• $1.6M in annual costs
|
•less $.12M
(6% tax)
|
• $.4M net
|
•$.280M net
($.4M-$.12M) |
In this example, the sales tax lowers the net proceeds of the
business from $400,000 to $280,000. Note
that the tax rate on the net return
($120,000 is 30% of $400,000)
is five times greater than the 6% nominal
rate on gross sales. That feature of the sales tax is five
times
greater
than
the 6% nominal
rate on gross
sales. That feature of the sales tax
is not obvious to casual inspection. Nevertheless,
in this particular case, the high original
margin is
enough to provide a
cushion to absorb the effects of the
sales tax and stay in business.
Now, imagine a similar small business in a peripheral
neighborhood without that margin and examine the
effects of
the sales tax on its operations.
| Before sales tax |
After sales tax |
| • $400K in annual sales |
• $400K in annual sales |
• $350K in annual costs
|
•less $24K
(6% tax) |
• $50K net
|
•$26K net
($50K-$24K) |
In this case, the initial margin of $50K gave the owner just
enough to keep the store open.
(Let us assume the owner could make $40K
in an alternative
job.)
By lowering the net return to $26K
(an almost 50% tax rate on the net return), the sales tax
can be
observed
by
driving through
any
low-income
neighborhood:
rows of service businesses such
as beauty parlors, barber shops, and so on,
but very few stores selling taxable
merchandise.
The surprising benefits of a tax on
land values
We have just seen how a tax on
sales eliminates a small business
but only
damages the larger
one in
a more
central location.
A tax on the
value of
land (like
the property tax, but without
the tax on buildings) has exactly
the
opposite
effect.
It encourages the development
of small business and eliminates
the
implicit
subsidy to big business. It does
so by shifting from upfront capital costs (which favor big businesses
with access to credit) to variable costs that can be paid out
of the annual profits of a business. The main reason this is
the case is that small businesses generally use space more efficiently
and pro-duce more value per unit of land cost than a large business.
Thus, in a competitive environment, in which market forces compelled
each owner to utilize space opti-mally, small business would
be able to expand its share of the national economy by a large
percentage. Many apparent economies of scale would disap-pear
under those conditions.
Although it is impossible to create a realistic simple example
of the effects of land value taxation two businesses, I will
continue with the examples above,
while asking you to keep in mind that oversimplification distorts important
features of the situation. Let us suppose in the example above
that the centralized business
is located on land worth $2M because of its prime location. The peripheral
business is on land worth $100K. Let us imagine that the tax
is equal to 10% of the original
land value, before the tax is imposed. (The actual math is more complicated
because the price of land would fall as the tax rate rises
[thus absorbing more of the
land rent, ed.], but we need not concern ourselves with that here.)
The large, central business now pays $200K in tax (up from $160K,
and the small, peripheral business pays $10K (down from $24K).
The small business is still
able to operate at that profit margin, so the shift from the sales tax to
the land
value tax has increased its competitiveness against the large, central business.
It might seem from this example that the land value tax is arbitrarily
biased against the large, central business and that it would
encourage the decentralization
of business. That is not the case. By raising the cost of holding central
locations idle (like empty lots used for parking in or near the business
district) a
land value tax would promote intensive redevelopment of core urban areas.
The “bias” is
in favor of allowing people to return to cities from which they are currently
excluded by speculative landholding.
Conclusion
For over a century, economists, historians, and social critics
have been telling the American public that big business dominates
our economy because
it is more
efficient than small business. But that is not true. Giant corporations
control an increasing proportion of market share in many fields simply
because of
their political advantages and their differential access to credit. They
have been
able to create a regulatory climate that excludes new entrants, they
have maintained local political connections that allow them to
own he best locations
for business
in metropolitan areas, and they have succeeded in promoting tax policies
that differentially destroy small businesses while only marginally harming
large
ones.
There have been dozens of efforts by citizen activists to rein
in the power of big business. Most of those efforts, such as
regulations and
efforts
to subsidize
small business, have unusually had the inadvertent effect of helping
large businesses instead.
One of the few effective means of restoring the rightful place
of small business in the U.S. is by creating a tax system that
is genuinely
neutral in its
effects. The centerpiece of such a tax reform would be the introduction
of land value
taxation. One consequence of that reform would be the elimination
of the largest implicit subsidies that big businesses have
always enjoyed--relatively
low
taxes on their land holdings.
The most important point to keep in mind is that small business
is naturally vigorous and competitive. Reform should not aim
at giving
any special
privileges to small businesses. They don’t need any. Small businesses simply need
an even playing field that enables them to show that they art more efficient
in many cases than the giants who currently control the economy.
