The “Small Business” Exemption Distortion

Many of the federal regulatory and tax laws include a “small business exemption” – politicians displaying an aversion to crippling a politically powerful constituency.  Often this is done by a cap – “This law will not apply to businesses having net annual sales less than some amount.”  Years ago, I saw one consequence of this law in the organization of the US scrap industry.  A prospering scrap firm would approach the cap ceiling and re-organize into two smaller businesses — sometimes one brother would head one firm, another the other.  Nothing wrong with this, save the transaction costs of creating two organizations rather than one.  But these costs may indeed be large – duplicate job slots in the firms, separate marketing and production departments and so forth.

The value of small businesses is that some do not stay small.  Those that grow – for example, the Microsofts of tomorrow – are not benefited by laws that artificially penalize growth.  Like caps on welfare and other redistribution programs, they can encourage firms to avoid the risks — and the benefits — of growth.