Will Small Business have Turn at Trough?

"Where is our bailout?"

This is the consistent cry we have been hearing from small business owners on Main Streets across the US over the past few months.  Be careful what you wish for.

With word that SBA backed loans are failing at a rate of almost 12%, the Obama administration has added a big bucket of cash from their "We are All Socialists Now" Act of 2009 to beef up the SBA's coffers.

This is the worst thing we could possibly do to help small businesses at this time.

A major contributor to the troubles that many small businesses are facing is excessive debt.  Although debt may have seemed to help out in short run, it only tightens cash flow over the long-run.

Debt payments become yet another fixed cost that pushes breakeven up even further.

Let's look at an example -- say, an entrepreneur named Angel makes hand-made guitars.  Assume she makes $100 on each of the 50 guitars she sells each month.  Angel is able to take out an SBA loan to upgrade some equipment and to pay for a new website.  This loan will obligates her to a monthly payment of $1,000.  To maintain current profits, Angel must now sell 10 additional guitars each month just to cover her loan payment.

When times are good we might be able to justify her loan as an investment in growth.  But this is not a time of growth for most small businesses -- it is a time to survive.

Now assume that instead of making more credit available for small businesses we cut the income tax rate by 5%.  Since virtually every small business in the US is a pass through entity, all profits pass through the entity and becomes part of the owners' personal income. 

Now Angel will be able to keep a little more of the $100 profit she makes on each guitar.  If her sales drop due to the recession, she will not need to sell as many guitars to keep afloat.  And if she can keep her sales steady, she will have a little more money available each month that she can spend, thus helping the other small businesses she buys stuff from.

I know what all you Keynesians and born-again Keynesians out there are saying right about now. "Wait a minute Professor Cornwall.  Angel's spending is not enough to help us right now.  Uncle Sam is the only one who can spend us out of this recession."

But, history shows us that you are wrong.  Keynesian policies never worked as advertised.  I agree with Mitt Romney's comments from an interview with James Pethokoukis of US News & World Report:

First of all, the economy is too big for the government to think it can pull a string and the economy will jump. It is a global economy and what is happening here will be affected by what is happening around the world. ... So the best thing our government can do is encourage the conditions that allow new business to grow and old businesses to expand. And that means reduce burdens on them, provide incentives for them, encourage Americans to invest in them, build the pool of risk capital again, each of these things helps the private economy grow and that's how you create jobs and that's how you get us out of the doldrums we're in.

And that means cut Angel's taxes so she can grow her business, make more money, add some jobs, and invest her profits to start to re-build her retirement portfolio.