What Is the Role of Small Firms in the Labor Market, and How are Small Firms Affected by Federal Policy?

March 12, 2012

Policymakers, analysts, and the public continue to express concern about the prospects for job creation. Although the most recent recession ended more than two years ago, the recovery has been slow, and the economy remains in a severe slump.

From December 2007 (when the recession began) to February 2010 (when the number of people on business payrolls was at a low point), the U.S. economy lost 8.7 million jobs, on net, on a seasonally adjusted basis. From February 2010 to February 2012, only 3.5 million jobs were created, on net, on a seasonally adjusted basis. CBO projects that, under current law, employment will grow at an average rate of about 2 million jobs per year over the next few years. At that rate, employment will not reach its prerecession peak until the middle of the decade.

In a report on small firms, employment, and federal policy released today, CBO examined the following questions:

  • Do small firms spur more job growth than large firms do?
  • What happened to employment at small and large firms over the past few years?
  • What are the advantages and disadvantages that varying policies by firm size could have for overall job growth?
  • How do federal laws and regulations affect small firms?

Do Small Firms Spur More Job Growth than Large Firms Do?

Small firms are sometimes described as the engine of job growth, but the more accurate view is that new small firms are a particularly important source of job growth.

Small firms employ a substantial share of all workers and are among the most dynamic employers in the economy. That very dynamism, however, leads small firms to both create and eliminate jobs at higher rates than larger firms do, in part because small firms come in to and go out of existence at much higher rates than their larger counterparts—a pattern that persisted through the most recent recession.

So, while small firms do generate jobs at higher rates, on net, than larger firms do, that relationship arises primarily because new firms, which typically start out small, create a comparatively large share of net new jobs. Conversely, older, more established small firms create a comparatively small share of net new jobs.

What Happened to Employment at Small and Large Firms Over the Last Few Years?

During the recent recession and the following 18 months (that is, between December 2007 and December 2010), the number of private-sector jobs declined by 6.6 percent, on net, with declines occurring in all categories of firm size. According to CBO’s analysis, small and medium-sized firms suffered disproportionately greater job losses than large firms (see the table below).

Firm Size, by Employee Count Change in the Number of Workers Between December 2007 and December 2010
Fewer than 50 workers -7.1 percent
50 to 499 workers -8.1 percent
500 or more workers -5.4 percent

Whether the recent recession has been unusually difficult for small firms is unclear because historical data are not sufficient to establish a typical pattern for job losses during recessions. In contrast with the recent recession, large firms experienced substantially more net job losses than small firms did during the 2001 recession.

What Are the Advantages and Disadvantages That Varying Policies by Firm Size Could Have for Overall Job Growth?

The greater net job-creation rates associated with new small firms could motivate lawmakers to consider supporting such firms through various policy initiatives. However, policies specifically favoring small firms have both advantages and disadvantages. For instance, policies designed to prevent discrimination or reduce pollution would probably have smaller adverse effects on employment if they exempted small firms in those cases where compliance was particularly costly for small firms. Conversely, some policies CBO has examined that would increase employment, such as reducing payroll taxes for firms that hire additional workers, would be less cost-effective if they were restricted to small firms. Because further efforts to favor small firms may shift employment away from large firms in an inefficient manner, broadly targeted policies may spur total employment more effectively.

How Do Federal Laws and Regulations Affect Small Firms?

The ability of all firms to expand or become more efficient—that is, to produce goods and services in a more cost-effective way—is influenced by federal policies that determine the taxes those firms pay, the availability of credit, the regulations with which they must comply, and other factors. In many cases, the current federal policy environment is more favorable to small businesses than large ones; in other cases, the reverse is true.

Among the ways in which small firms receive more favorable treatment than larger firms are:

  • A reduced capital gains tax for investments in small firms,
  • Tax provisions having the effect of allowing small firms to immediately deduct a larger share of their costs for certain capital investments,
  • Assistance from the Small Business Administration (SBA), through loan guarantees that enable small firms to borrow at more attractive terms (for example, lower interest rates and fees) than they might otherwise obtain, and
  • Exemptions from some regulatory policies, such as the Family and Medical Leave Act of 1993.

The recent financial crisis disproportionately affected small businesses’ access to capital. To increase the supply of credit to small firms, the American Recovery and Reinvestment Act of 2009 raised certain loan limits under the SBA’s programs, as did the Small Business Jobs Act of 2010.

This brief was prepared by Gregory Acs, formerly of CBO, and William Carrington of CBO’s Health and Human Resources Division.