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What's the Best Outcome for Small Business on the Fiscal Cliff? (Opinion)

Entrepreneurship professor Scott Shane's insights on how spending cuts and tax increases could affect you.
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Within hours of the presidential election, Washington politicians turned to the most urgent issue facing them: the fiscal cliff looming on Jan. 1, when more than $100 billion in automatic spending cuts and $500 billion of tax increases will be triggered.

President Obama quickly made his position clear: Congress must raise taxes on Americans earning more than $200,000 a year as part of any compromise to keep the U.S. from going over the fiscal cliff. Speaker of the House John Boehner was equally direct: Preservation of the Bush tax cuts for everyone must be part of any deal. As political leaders play a giant game of chicken with the economy, what’s best for small businesses?

Not the position of liberal economist Paul Krugman, who recently argued in his New York Times column that doing nothing would be better than preserving the Bush tax cuts for higher-income earners. Small-business owners know that reaching a compromise would be much better than going over the fiscal cliff. 

Related: The Fiscal Cliff: 3 Tax Changes You Need to Know Are Coming

If a compromise isn’t reached on the spending cuts and tax increases scheduled for 2013, the Congressional Budget Office predicts that the U.S. could fall back into a recession next year, with unemployment rising to 9.1 percent. That’s clearly bad news for small business, which has not yet recovered completely from the recession. Bureau of Labor Statistics data reveal that 5.3 percent of self-employment disappeared and Federal Reserve data show that self-employed households lost 11 percent of their real income. Moreover, another recession would curtail consumer spending and reduce revenues for already struggling small businesses. 

Kicking the can further down the road may be the best option for small businesses at this point. A one-year extension of tax cuts and delays in automatic spending cuts look a whole lot better than the prospect of a recession in 2013. Sure, that approach contributes to economic uncertainty, which makes it difficult for small-business owners to plan. But there are two redeeming qualities. First, lawmakers would have more time to work out a solution to the debt problem that makes spending cuts to less essential programs rather than across the board, as well as time for tax increases so they don’t all come at once and cripple the economy.

Second, our national debt is a long-term problem, not an immediate crisis. The CBO report says postponing the tax increases and spending cuts “indefinitely” would “raise the risk of a fiscal crisis” that “would eventually” have adverse effects. Choosing a recession in 2013 to avoid greater odds of economic problems some time in the future is a bad deal. As economist John Maynard Keynes once said, “The long run is a misleading guide to current affairs. In the long run we are all dead.”

But what if a one-year extension isn’t possible? Knowing that if a compromise isn’t reached between Speaker Boehner and President Obama, the result is a likely recession, should small-business groups back Boehner’s insistence that the Bush tax cuts be preserved for everyone or should they acquiesce to the President’s call for higher tax rates on people earning more than $200,000 a year? 

Related: Barack Obama's Second Term Small-Business Agenda

If small-business groups are worried about doing what’s best for most small-business owners, then their best course of action is to call on Speaker Boehner to concede his position. Only about three percent of small-business owners will be affected by the President’s plan to let the Bush tax cuts expire on the highest income earners. Raising taxes on three percent of small-business owners to avert a recession is a good deal for the vast majority of businesses.

However, that approach assumes small business groups are concerned only with doing what’s in the best personal interest of the majority of small-business owners. In reality, they also care about economic philosophy. Most small-business advocacy groups believe the studies that show that raising taxes on small-business owners earning more than $200,000 a year will cause their companies to cut back on capital investment and hiring. Because these companies create a lot of jobs and account for much of the contribution that small business makes to Gross Domestic Product, the advocacy groups contend that allowing the Bush tax cuts to expire on higher earning small-business owners will adversely affect the economy. However, the CBO believes this effect would be modest, cutting real GDP growth by only 0.2 percent in 2013, the Wall Street Journal reports.

What small-business groups should advocate comes down to a fundamental question: Do they believe in their own economic analysis enough to risk a recession that could hurt many small-business owners in a game of chicken over taxes on the highest earning Americans?

Related: Hidden Cash: Tap Into R&D Tax Credits