We Should Still Abolish the SBA: The $45 Million "Small Business" Edition

On the Fourth of July, because nothing says “Liberty!” like a bigger federal subsidy, the Small Business Administration doubled the ceiling on its guaranteed loans to $10 million, the most it has ever offered. The symbolism is almost too perfect. Few phrases in American politics are as sacred as “small business.” It conjures images of corner hardware stores and family farms. What it protects is something else.

Consider – as Wharton’s Brian Feinstein did in the WSJ – what Washington means by “small.” A homebuilder pulling in $45 million a year qualifies. So does a manufacturer with 1,500 employees. In the median industry, the revenue ceiling runs around $21 million; in some it reaches $47 million. That $45 million builder is larger than 99 percent of American firms with any employee other than the owner, and at construction’s typical margins, its proprietor clears roughly $2.7 million a year. This is not the plucky underdog of campaign ads. It’s a prosperous, established company collecting benefits that most Americans believe are going to the underdog.

And there is a lot to collect. I wrote about one of Feinstein’s studies a few months ago, that showed how much small businesses are receiving in various forms of corporate welfare. To get the answer, he combed the entire U.S. Code of Federal Regulations and counted more than 1,300 separate measures that hand small firms some advantage, like set-asides, subsidized credit, regulatory carve-outs, procedural rights. Over the last half-century, the small-business portion of the Code has grown about seven times faster than the rest of the Code.

Contracting preferences alone steer north of $170 billion a year toward firms that clear the “small” bar, chasing a statutory target of at least 23 percent of prime contract dollars. Small firms even get relief from certain civil-rights, food-safety, and hazardous-waste obligations.

This apparatus does real damage in three directions.

First, it taxes growth. When crossing a size line means forfeiting valuable exemptions and preferences, the rational move is not to cross it. That is exactly what the Feinstein data show: firms pile up just beneath their industry’s threshold in numbers that no natural process can explain. We have built a policy that pays companies to stay below an artificial threshold of size and revenue. In some cases, that means declining the 1,501st hire or leaving the profitable expansion on the table. A subsidy for smallness is a penalty on getting bigger and more efficient.

Second, the rest of us pay. Contracting preferences don’t produce better vendors; they require agencies to pass over more qualified bidders in favor of those that fit the definition. And, of course, taxpayers foot the bill when “small” businesses default on their government-guaranteed loans.

Third, it is cronyism and it unfair to all the small, no matter how one defines it, companies that don’t get a government leg up.

Defenders will fall back on the familiar catechism: small firms are the great job creators and innovators, so taxpayer help pays for itself. I’ve spent a good part of my career arguing this is a myth, and the evidence keeps cooperating. Job creation is a story about age, not size. New firms start small and, if they succeed, grow. That’s where the dynamism lives. Mature small firms are neither special job machines nor innovation hothouses: most never patent, fund research, or trademark a name, and the ones that do rarely stay small for long. Strip away the myth, and the case for favoring smallness collapses. (Note: I am also against favoring big firms.)

Which brings me back to the SBA and its enlarged loan guarantees. What market failure, exactly, is this agency correcting? The textbook answer is information asymmetry: lenders can’t always separate good borrowers from bad, so some worthy firms go unfunded. That might happen. However, unlike government bureaucrats, banks have the right incentives to figure it out so they don’t overlook potential borrowers that will make them money. This argument also ignores the fact that not every denial of a loan is a market failure. So here’s the question defenders never answer: granting that such “failure” sometimes occurs, what makes the SBA able to fix it?

To beat the market, you need corrective capacity, better information, superior incentives, a better way to screen, and a tool that changes what lenders can see. The SBA has none of these features. Its guarantee doesn’t find the good-but-overlooked borrower in the reject pile; it eats 75 to 85 percent of the loss on whoever clears an eligibility box written for political and definitional reasons, not to reveal who’s creditworthy. Worse, even granting actual market failure, the program doesn’t cure any of it and plausibly makes the allocation worse than the private baseline.

And the whole case for the SBA rests on a buried assumption: that a firm’s failure to raise capital proves that a good project was missed. Yet it proves no such thing. Not every project deserves funding, and the fact that not everyone can borrow is a feature of a working market, not a defect. Rationing is the market doing its job. Our private capital markets, the deepest on earth, spanning venture funds, private credit, community banks, angels, and crowdfunding, deploy trillions a year in search of anything viable. When a company with a credible plan and real collateral still can’t find a taker, the honest reading isn’t that thousands of profit-hungry investors missed it. It’s that the market returned an accurate verdict.

By design, the SBA then overrules that verdict. That’s not a hidden talent for spotting winners; it’s a mandate to bankroll the businesses the market already passed on. (The agency’s alleged low default rates look far less flattering measured honestly, by cohort.) And the most reliable beneficiaries aren’t the borrowers. Banks originate the paper, sell the guaranteed slice, and pocket the spread while taxpayers hold the risk. The Main Street story is the marketing. The banks are the customers.

Feinstein’s own fix is sensible as far as it goes: replace cliffs with ramps, so obligations phase in as a firm grows instead of dropping a trapdoor at employee number 1,501. I would go further. When a privilege can’t be justified on its merits, it shouldn’t exist for small firms or large ones. Deregulate for everyone, rather than granting some exemptions. And an agency whose core function is to lend where private markets won’t should be wound down, not handed a bigger checkbook on the Fourth of July.