Key provisions of Senate and House small-business bills

The bill passed the Senate on Thursday and will return to the House, where a similar version of the measure was passed in June.

Small businesses will benefit from increased credit from community banks as well as tax relief. But these benefits are likely to be overshadowed by other factors: Banks have to be healthy enough to lend, and small businesses have to demand the loans. The bill’s tax credits, while helpful to many small businesses, will probably not guide business decisions to expand and grow the economy.

Supporters of the Senate’s version say the bill will indirectly affect small-business growth and job creation. The bulk of the legislation calls for the Treasury to make investments in community banks, but the incentives for those banks to increase small-business lending would be weak.

Here are key tenets of the Senate bill:

Small Business Lending Fund

The $30 billion Small Business Lending Fund, to be established at the Treasury Department, would tend to the business of investing in so-called community banks. These financial institutions have assets equal to or less than $10 billion. The size of the equity stake is small, ranging from 3 to 5 percent of risk-weighted assets, allaying concerns about government influence over banks’ lending decisions. 

In return for the preferred equity stake, banks would be required to pay the Treasury a 5 percent dividend payment. Over a two-year period, this rate declines on a sliding scale based on increases in banks’ small-business lending portfolios. The more these banks lend to small businesses, the smaller the dividend payment to the Treasury.

For example, if a bank increases small-business lending by 2.5 percent, its dividend payment to the Treasury declines to 4 percent.

If the opposite is true, payments go up. After a two-year period, if banks have not increased small-business lending, the dividend payment increases to 7 percent. The program also has a pricey incentive built in to encourage banks to repay the Treasury and get out of the program: After four and a half years, dividend payments on all participants in the program leap to 9 percent.

The program is structured, however, in a way that leaves the Treasury with few teeth to ensure that community banks are using Treasury funds to increase small-business lending. While banks that increase lending to small businesses pay the Treasury a smaller dividend payment, there is no financial penalty for failing to increase lending during the first two years. This does little more than encourage banks to participate in the program.

The bill also provides $900 million for a State Small Business Credit Access Fund to supplement state programs to increase and support small-business lending.

What are the tax breaks?

This part of the bill is intended to encourage business investment and hiring to the tune of $7.7 billion for advanced depreciation and tax deductions for qualifying investments in property. But the impact of the tax breaks may be limited: They extend existing stimulus programs that expired at the end of 2009 or are due to expire at the end of 2010.

The bill also includes a tax deduction for qualifying investment in personal property, such as restaurants and retail space. This extends existing stimulus legislation to 2010 and 2011, and significantly raises the threshold for the tax write-off.

The largest tax incentive would allow small businesses to accelerate the depreciation schedules for qualifying capital investments. This would reduce tax liability for 2010 and is intended to encourage them to invest more during the rest of this year. This bonus depreciation was passed in 2008 and was extended by the Recovery Act for 2009 and 2010 for qualifying projects.

Changes to tax code

The bill includes more than a dozen changes to the tax code that would increase small businesses’ access to capital and reduce their tax liability. However, these measures remain a relatively small portion of the overall legislation.

All together, we’re talking about $4.3 billion in tax breaks over 10 years.

The most costly new tax provision allows small-business owners to deduct the cost of health insurance when calculating the self-employment tax. This measure is among the largest of the tax breaks in the bill, costing the government $2 billion over 10 years.

The breaks also include the elimination of the capital gains tax on the sale or exchange of small-business stock, a provision that has received significant attention. By reducing the tax liability for investors, the measure encourages equity investment in small businesses, thus increasing businesses’ access to equity capital. 

Measures to decrease small businesses’ tax liability include a provision that would allow the general business credit to be carried back five years, reducing past years’ tax liabilities. 

Another provision enables small businesses to deduct business credits against the Alternative Minimum Tax (AMT).

Other provisions in the legislation would reduce fees, increase market access and establish a credit access fund for state-run lending programs. One would eliminate fees associated with loans made by the Small Business Administration. Another would temporarily increase the deduction for business startup costs from $5,000 to $10,000 for 2010 and 2011. 

Aside from the lending and tax perks, additional programs are intended to increase small-business competitiveness in international trade by promoting exports and market access.

Differences between the House and Senate Bills

While it deleted and changed very little, the Senate did make significant additions to the legislation, particularly regarding measures to increase business investment and cut small-business taxes.

The Senate nixed one program that appeared in the House legislation to promote early-stage business investment and reduce the maximum deduction for business startup costs from $20,000 to $10,000.

The most significant additions by the Senate are the tax breaks on investment, the carry-back of the general business credit, the AMT tax, the healthcare deduction provision, the Small Business Administration fees elimination and measures to promote exports. 

Other provisions added by the Senate collectively account for less than $1 billion over the next 10 years and are likely to have a minimal impact on small businesses or the economy.

Economic impact

Small-business lending fell from $710 billion in the second quarter of 2008 to less than $670 billion in the first quarter of 2010, according to Federal Reserve Chairman Ben Bernanke. What is unknown is what caused the decline in lending. Was it because credit was hard to come by, or because demand for small-business loans was just weak?

One community bank CEO testifying before the Senate Committee on Small Business and Entrepreneurship said the bill will expand small-business lending by $300 billion and will reach more than 8,000 community banks. 

But this may not pump up small businesses' bottom lines. Banks’ unhealthy balance sheets may restrain the supply of credit, and weak consumer demand may reduce the demand for small-business loans.

The tax provisions in the bill, while putting some capital back in the hands of small-business owners, are modest and may be insufficient to overcome businesses’ anxiety about the weak economy. 

Is it just ‘TAPR Jr.’?

Some conservatives have labeled the $30 billion loan fund as the successor to the TARP bailouts, saying that the bill is simply a backdoor way for community banks to get rescue funds like their big brothers on Wall Street. Like larger equity stakes made in Wall Street banks by the TARP legislation, the equity stake by the Treasury may fail to induce small-business lending. This is especially true for severely undercapitalized institutions.

Many community banks are still undercapitalized. In the second quarter of 2010, 45 FDIC-insured banks failed and the number of “problem banks” rose from 775 to a recent peak of 829. Although “problem banks” are excluded from the bill’s loan fund, many small banks face similar risks. Unfortunately, undercapitalized institutions that need the Treasury’s help the most will be in the worst position to extend credit to small businesses.

For the largest community banks (those with assets greater than $1 billion and less than $10 billion) the stake cannot exceed 3 percent of risk-weighted assets, a relatively small infusion when compared to potential losses on commercial real estate loans and other assets. Compared to the stake the Treasury took in Citigroup or Bank of America, banks that actually reduced small-business lending under TARP, the proposed equity infusion into community banks is minuscule.

Another criticism of the legislation is that there is no mechanism to force banks to lend. Community banks are required to pay a 5 percent dividend to the Treasury, but this rate does not rise if banks fail to increase their small-business lending portfolio. According to the payment schedule outlined in the legislation, banks can even accept the Treasury’s money and reduce their lending to small businesses for two years, while continuing to pay the 5 percent dividend rate.

Weak loan demand

Weak banks remain a key concern, but a far greater problem is whether or not small businesses need more bank loans. 

Although the data on small-business lending remains quite poor, surveys of large banks’ small-business lending portfolios suggest that loan demand among small businesses is flagging. According to a report by the Congressional Oversight Panel, small-business portfolios at the largest banks fell by 5 percent more than their overall lending. According to data from the Federal Reserve’s Senior Loan Officer Opinion Survey, commercial and industrial loan demand from small firms remained unchanged in the second quarter of 2010, after declining every quarter since 2006.

The weak loan demand may reflect different intentions on the part of business owners from what lawmakers wish. A monthly survey conducted by the National Federation of Independent Business (NFIB) reported that only 1 percent of small-business owners plan on creating new jobs in the next three months. 

According to NFIB chief economist William C. Dunkelberg, “Weak sales and uncertainty about the future continue to hold back any commitments to growth, hiring or capital spending.” While access to bank credit is necessary for expansion, small businesses appear more concerned with sluggish demand.

And those tax breaks …

Some of the tax breaks in the bill will be spent by small businesses. However, if demand remains weak, those businesses will be reluctant to spend. So the overall impact of these tax breaks on the economy will be small.

Example: For every dollar in tax breaks for bonus depreciation, the economy only grows by 25 cents. The $5.5 billion tax break for bonus depreciation would only increase GDP by $1.4 billion, according to Mark Zandi, chief economist at Moody’s Analytics. Of all the options for government stimulus, bonus depreciation is among the worst in terms of bang for the buck. 

Again, businesses are reluctant to spend and hire because of a weak consumer sector. Many businesses also have significant excess capacity, indicating that they can increase output without more investment. More factories are in use now than at this time last year, but excess capacity today is consistent with levels seen at the depths of many previous recessions.

All of the tax breaks in the bill would increase 2010 GDP by a mere 0.05 percent.

The author, Sam Sherraden, is a policy analyst at the Economic Growth Program of the New America Foundation.