Are High Taxes Making Small Business Slow to Hire?

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The majority of jobs in the U.S. are created by small business, and for some time now, small business has been reluctant to hire new workers. Big business, meanwhile, is doing just great without such hiring. It generated $1.66 trillion in profits in 2010 and piled up nearly $2 trillion in cash reserves as productivity rose 2.6% while labor costs fell 1.5%.

The obstacles to hiring for small businesses are in large part similar to those of their larger counterparts, but local conditions -- the costs of doing business in their state -- may loom larger in their decisions. For example, one small business in Massachusetts may be holding back due in part to the state's 14% higher-than-average worker-related costs. Those taxes, while annoying, are a relatively minor factor. Which leads to the question: What should government's role be in job creation?

For small business, the decision-making calculus for hiring a new workers is pretty straightforward: Will hiring an additional person safely generate enough profit to offset the cost of that new hire? And in the case of Marathon Tools, a Massachusetts hardware store whose story was featured in the Boston Globe, the answer is "not yet."

For Marathon, which saw its sales peak at $4 million in 2006, the $39,783 cost of hiring a new worker -- $35,000 salary plus $4,783 in insurance premiums and taxes -- would require sales of 20 million more nails annually.

A High Price for Hiring ... and for Laying Off

How important is small business to the national hiring picture? Between 1993 and 2009, 65% of the 15 million net new jobs created in the U.S. came from companies with 500 or fewer employees, and most of the job growth came from the 5% to 6% of all firms that the Department of Labor calls "fast-growing high impact small firms." Of course, many small businesses are like pilot fish living off the economic scraps that escape the jaws of the economy's enormous sharks. And when the food supply shrinks, small businesses have to adapt fast.

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That's what happened to Marathon Tools, which flourished during the housing boom that peaked in 2006. Between 2009 and 2010, as its sales fell 60%, Marathon laid off five people, which meant paying another $10,000 into the state unemployment insurance pool to cover its share of the liability. Faced with rising health care costs, Marathon eliminated health care coverage for its workers in exchange for a one-time payment as high a $5,000, according to the Globe.

There are glimmers of hope for Marathon. That's because contractors in Massachusetts -- where the unemployment rate was 8% in December 2010, well below the nation's 9.1% rate -- are starting to go back to work, and they're buying more of those 4,000-nail cases from Marathon's warehouse. But as demand has increased, Marathon has extended the hours of its existing staff rather than hire new workers.

According to Marathon, those state-imposed costs are causing it to postpone hiring. To add one $35,000-salary counter worker, Marathon would need to pay:

  • State unemployment insurance premiums: $1,750, 5% of base salary
  • Federal payroll taxes: $2,170, 6.2%
  • Workers' compensation insurance: $583, 1.7%
  • Federal unemployment insurance: $280, 0.8%
Is 13.7% Hiring Tax Too High or a Good Value?

Those additional taxes and insurance premiums represent 13.7% of the worker's base salary. Whether you think that represents too high a tax on a business to create a new job largely depends on your values. If you believe that the government ought to help workers who lose their jobs or get hurt at work, then it probably won't bother you. Nationwide, 30 million people are without work -- many of whom are glad that government is providing this service. If you believe business should not be shackled by such costs, you probably think that 13.7% tax is outrageous.

For many Massachusetts businesspeople, the costs of uprooting their operations and relocating to states with lower taxes probably exceed the benefits of reducing those state-imposed costs. And as I wrote in Capital Rising: How Global Capital Flows Are Changing Business Systems All Over The World, co-authored with Srini Rangan, startups locate themselves where the entrepreneurial ecosystem (EE) -- corporate governance, financial markets, human capital and intellectual property protection -- is most favorable.


In Massachusetts, the EE is favorable to many businesses that depend on human capital and intellectual property. Its relatively low unemployment rate is explained by the fit between the high-tech, investment management, and consulting firms and those key EE elements located there. Marathon sells to builders who construct homes and offices for their workers.

As such, the many EE benefits of staying in Massachusetts far offset the somewhat higher taxes and insurance fees. So they'll stay put. But -- like thousands of small businesses across the country -- they are going to delay hiring new workers until their existing staff absolutely cannot work any longer hours.

And for Marathon, Massachusetts' higher insurance premiums and taxes may delay a new hire for a little while longer once its existing staff gets stretched near its limit. But if the lost opportunity from not hiring a new person at its counter gets high enough, Marathon will gladly pay the $39,783 to capture it.

The nice thing about small businesses like Marathon is that most of its jobs cannot be outsourced. The same cannot be said for the economic sharks that are prospering so effectively in a nation with a 9% unemployment rate.
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