May 3, 2018

Ten Problems with Small Business Administration Subsidies

Tad DeHaven

Research Analyst

It’s Small Business Week according to the Trump administration. For the federal government’s Small Business Administration (SBA), it’s an opportunity to score public relations points with press releases and events associating itself with a segment of the economy that, unlike large corporations, garners the public’s empathy. Unfortunately, that empathy is why the SBA’s politically self-serving portrayal of its beneficence and importance to the small business community will go largely unchallenged.

There is nothing wrong with celebrating those intrepid entrepreneurs who are willing to accept the high risks and hard work that come with forming and sustaining a business. These men and women often do so in the face of discouraging regulations, red tape, and taxation. The SBA and its subsidy programs, however, privilege a relatively small number of firms at the expense of the vast majority of firms who do not receive federal support. So, with Small Business Week as the backdrop, here are ten reasons why the SBA and its subsidy programs should be challenged:

1. SBA’s subsidies benefit a few at the expense of many. An analysis from the Government Accountability Office found that the SBA’s flagship 7(a) subsidized loan program (more than 90 percent of all non-disaster SBA loan guarantees come from the 7(a) program) only accounted for a bit more than 1 percent of total small business loans outstanding.

2. The industries that benefit the most from SBA subsidies include restaurants, gas stations, beauty salons, and dentist offices. And those firms that received SBA-backed loans represent only a tiny fraction of the total number of firms in those industries. Why is it the role of the federal government to privilege a small number of firms in common, competitive industries?

3. When a pizza restaurant receives financing backed by the federal government, it means that competing pizza restaurants that didn’t receive any subsidies have been disadvantaged. Those in other industries who are seeking financing are also disadvantaged as they are either going to miss out on financing or will have to obtain it on less favorable terms. The federal government should remain neutral in the economic decision-making process instead of effectively picking winners and losers.  

4. Subsidies and politics go hand-in-hand. A new rule from the SBA would prohibit lenders from using SBA-backed loans to finance businesses involved with marijuana. At the same time, the SBA is celebrating a brewery in Massachusetts that it subsidized. It’s also celebrating a winery from New Mexico this week. The federal government shouldn’t subsidize marijuana businesses, but it shouldn’t be privileging select breweries and wineries either. Subsidies politicize commercial activity, which leads to politicians deciding what businesses are “good” and what businesses are “bad.” Those are decisions that should be left to the consumer.

5. SBA proponents argue that the subsidies are needed to correct a “market failure” in commercial lending. That is, lenders fail to meet the financing needs of otherwise worthy small businesses because of the asymmetry of information between lenders and borrowers. However, innovations such as credit scoring and the building of “lending relationships” between creditors and borrowers have undermined this argument. It also ignores the large role that personal savings, assets, and credit cards tailored to small business can play in small business formation.

6. SBA proponents also argue that the agency’s loans incentivize lenders to offer financing to businesses that are unable to obtain “credit elsewhere.” But the relevant federal statute defines “credit elsewhere” as “the availability of credit from non-Federal sources on reasonable terms and conditions.” Not surprisingly, the GAO has found that businesses that received SBA-backed loans could have obtained non-subsidized financing. It’s worth noting that sometimes loans simply shouldn’t be made, but capital markets should make that determination – not political markets. Indeed, the large default rates on SBA-backed loans show that the government’s credit market interventions often misallocate capital toward wasteful ends.

7. Rare is the politician who doesn’t justify a government program on its ability to create jobs. But as a recent Congressional Research Service paper on the SBA and job creation notes, “Economists generally do not view job creation as a justification for providing federal assistance to small businesses. They argue that in the long term such assistance will likely reallocate jobs within the economy, not increase them.” Unfortunately, what the public sees are the press releases from the SBA and the corresponding favorable reporting from news outlets. What isn’t so readily seen (and, obviously, reported on) are the larger, broader economic losses stemming from these market-distorting subsidies.

8. The banking industry was opposed to the establishment of the SBA in 1953, but the banks had a change of heart when the SBA switched from directly lending itself to guaranteeing loans issued by lenders. The reason is simple: when an SBA-back loan goes bad, the bank gets reimbursed for up to 85 percent of the loan amount. That means that loans guaranteed by the SBA are largely risk-free to the banks and highly profitable.

9. SBA loan guarantees are arguably a form of “corporate welfare” for major banks. A recent list of the top SBA-backed lenders shows major banks like Well Fargo, JP Morgan Chase, and Huntington at or near the top.

10. Just because an SBA-backed loan technically went to a small business, it doesn’t mean that a larger business won’t be the ultimate beneficiary. In March, the SBA’s Office of Inspector General found that $1.8 billion in SBA-backed loans provided to chicken farmers were likely ineligible because the farmers were basically affiliates of large chicken processors. Again, the federal government shouldn’t be subsidizing businesses of any size, but this example does show how subsidy programs can be manipulated to the gain of unintended beneficiaries.