Wednesday, March 31, 2010

The health care bill introduces large taxes on firm growth

The health care bill passed by the Democrats includes a lot of provisions that depend on firm size, and which do not apply to firms smaller than some (arbitrary) limit. Most people like small firms and entrepreneurship. However both the left and the right often misunderstand sensible small business policy:

1. First of all, just because something is good, it does not mean the government should subsidize it. There are benefits (closer management control, fewer transactions costs, more flexibility) to small businesses, but there are also costs (less economies of scale, lower productivity). In a functioning economy some firms will be small and some firms large, depending on their relative advantages.

You need strong arguments, some form of important externality for example, for the government to tip the balance in favor of small firms.

Small firms are more expensive to insure, because of administrative costs, economies of scale and because large firms have the advantage of offering a large and diverse workforce that the insurance companies can pool.

Sure, this is “unfair” for small companies, but it also reflects real costs of the economy. In terms of efficiencies there should be fewer small firms because small firms have higher costs. It is “unfair” for Saab that Toyota has economies of scale and can offer the same quality cars cheaper. But that reflects real costs of the economy, there should be few large car companies because of the economies of scale in the car industry.

2. More important here: The main advantage of entrepreneurship is not that these firms are small, it is that they are growing. There is empirical evidence for this. Fast growing firms (“gazelles”) introduce new innovations into the economy, create new and better jobs and increase competition. We want small firms to grow if possible, not to stay small.

Here are some examples:

* The bill offer tax credits to small businesses who have fewer than 25 employees.

*The bill imposes a $2000 per employee tax penalty on employers with over 50 employees who do not offer health insurance to their full-time workers.

* The bill states that in firms with more than 50 employees nursing mothers must be allowed breaks, a year after giving birth, on the job to express breast milk as often as necessary; they must do so in a private place that’s not a bathroom.

* The bill states that chain-restaurants and food vendors with 20 or more locations are required to display the caloric content of their foods on menus, drive-through menus, and vending machines.

As bad as regulations are, they may have even worse effects if some firms are exempted, because in order to receive the exemptions firms behavior is distorted even more.

What the Democrat bill does is create an incentive for small firms to stay exactly below the limit (25 employees, 50 employees, 20 locations etc). This is similar to the unproductive Italian system, with lots and lots of small firms who escape regulations, but few Googles and Wall-Marts.

Italy, Greece, Turkey and Mexico have a much higher share of self-employed and more small firms than the U.S. But these is a reflection of low productivity, regulatory burdens, high taxes and large transaction costs, not entrepreneurship. The U.S has much more innovative entrepreneurship than these countries.

Helping small businesses stay small is not entrepreneurship policy, it is the exact opposite.


  1. Great article, but you really need to proofread it to get it up to your normal standards.

  2. I kind of liked Brad Delonge health care idea in which he used the hsa model as framework.

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