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.