Public Policy Toward
Small Business Economics
15: 283–291, 2000.
2001 Kluwer Academic Publishers. Printed in the Netherlands.
ABSTRACT. There is widespread support for tax policies
providing special treatment for small businesses. This paper
reviews standard efficiency and equity criteria for such tax-
subsidies, and finds they provide little support for such
policies. The review highlights a central empirical void
requiring further research: the “optimal” business failure rate.
Entrepreneurs do struggle, and small businesses frequently
merge and nearly as frequently fail. But we do not know
enough to determine which firms to target for success or
The image of the American entrepreneur retains
an enduring fascination in the minds of the public
and policy makers alike. For example, testifying
several years ago at a congressional hearing
on “the entrepreneurial spirit in America,”
Wisconsin’s Senator Robert Kasten said of entre-
preneurs: “They create new jobs. They provide
new competition to existing businesses. They help
to improve product quality, help to reduce prices,
add new goods and services never before thought
of, advance new technologies, America’s compet-
His statement captures the view that
entrepreneurial enterprises are valuable sources of
technological advance, jobs, and dynamism, a trait
commonly attributed to small business as a whole.
Our national affection toward entrepreneurs
also manifests itself in attitudes toward small
business. “Start-up,” “family,” and other small-
scale businesses carry an important weight in
discussions of national policy. This durable affec-
tion stems in part from the perception that small
business is the vehicle by which entrepreneurs
provide needed vigor to the economy.
In the newly established democracies of Eastern
Europe a widely discussed challenge is the need
to regenerate a vital entrepreneurial sector. The
centralized regime pushed the mass production
paradigm to its limit, at times concentrating the
entire production of a good in a single factory. The
dismal record of poor quality products and
stagnant economic growth highlights the need for
the competition and vigor provided by start-up
The national focus on small business is not
merely talk. Many government policies are
directed toward aiding small businesses. For
example, fulfilling a Clinton campaign promise,
the Revenue Reconciliation Act of 1993 (RRA93)
permits the exclusion of 50 percent of capital gains
on qualifying investments in start-up and small
businesses held for five or more years.
This paper surveys the various notions of
“small business,” presents criteria that should
underlie policies toward business, and reviews the
case for public polices to stimulate entrepreneur-
ship and small business. It concludes that it is
surprisingly difficult to construct a case in favor
of systematically favoring small businesses.
Indeed, it is probably not useful to think of
creating a “small business climate” through
policies like targeted tax breaks, wage subsidies,
loan guarantees or outright grants. Instead, policies
should be devoted to developing an environment
favorable to innovation, employment, and growth
in the economy as a whole.
2. Who are the entrepreneurs?
Entrepreneurs are usually characterized by their
daring, risk-taking, animal spirits, and so forth.
Final version accepted on October 26, 2000
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