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Nurture Small Businesses, Not Hinder Them

Susan Coleman

February 27, 2011

Small and entrepreneurial firms are a vital part of Connecticut's economy. Yet the state has a poor record of supporting them and needs to be careful not to form budget policies that would hinder them in the coming years.

Although we typically hear about the largest firms in the news, 99 percent of all firms in the United States are small, which according to the Small Business Administration means having 500 employees or fewer. These small firms represent roughly half of the gross domestic product and slightly more than half of all employment. They have generated 64 percent of net new jobs over the course of the last 15 years, according to the SBA.

From the perspective of keeping our nation globally competitive, small firms are also a major source of new products and services. They produce 13 times more patents per employee than large firms.

Small firms in Connecticut have a significant role in the economy. In 2007, the most recent year for which census data are available, Connecticut had approximately 75,000 firms with fewer than 500 employees. These firms employed almost 800,000 workers for an annual payroll in excess of $37 billion. Annual sales for these firms exceeded $200 billion. In addition to its 75,000 employer firms, Connecticut also had more than 250,000 firms whose owner is the sole employee. Although these firms do not provide jobs, they do provide goods and services as well as employment and income for the firm owner. This is all good news.

When we look at state vs. national trends over time, however, the picture is much less rosy. From 1990 to 2007, the number of U.S. firms with fewer than 500 employees increased by 19 percent and their employment also increased by 19 percent. In contrast, the number of small firms in Connecticut declined by 6 percent while employment hardly budged during that same time. How do we reverse this negative trend? What steps can we take to ensure that Connecticut is, indeed, "open for business"?

First, we need to change the message and the mind-set. In recent years Connecticut has developed a reputation, somewhat deservedly, of being an anti-business state. If our true priorities are jobs and economic growth, we need to dramatically change that way of thinking, because businesses and entrepreneurs are where the jobs come from.

Second, we need to avoid legislation and regulations that either raise costs or reduce the flexibility of small businesses. These are still challenging economic times, and many small firms are hanging on by a shoelace. They do not have the financial slack to absorb higher costs or the organizational slack to absorb greater regulatory complexity. For many, their major variable expense is labor. If something has to be cut at this point, it will be jobs.

Third, we need to align our state budget and infrastructure with our priorities. It is not enough to say that we aren't as bad as New York and New Jersey. That's not much comfort given that a recent report by the Tax Foundation ranks all three states among the top 10 states with the worst business tax climate. In that report, Connecticut dropped from 38th in the 2010 report to 47th this year.

We clearly have our work cut out for us if we want to encourage businesses to start, grow or relocate in Connecticut. Gov. Dannel P. Malloy has shown courage in his proposed budget by addressing the deficit as well as our high levels of indebtedness and unfunded pension liabilities. These are important steps in the right direction. Nevertheless, his budget does little to encourage small business growth or hiring.

Higher and expanded sales taxes will depress demand, higher gasoline taxes combined with rising oil prices will increase costs, and higher personal income tax rates will hurt many small business owners whose firms are organized as sole proprietorships, LLCs or S corporations. If our true priorities are jobs and economic growth, we need to start changing the climate for business with an eye toward these and similar issues.

Susan Coleman is a professor of finance at the University of Hartford's Barney School of Business.