The big economic issue the candidates aren't talking about

Elaine Pofeldt, special to CNBC.com
A protestor in New York City demands more jobs.
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Presidential candidates on both sides of the aisle — from Donald Trump and Sen. Ted Cruz to Hillary Clinton — have promised they can create more jobs in the United States. Their strategies include Trump's five-point tax plan to spur business and job growth; Cruz's idea to have a flat tax to stimulate business investment; and Clinton's proposal to invest in infrastructure, clean energy and scientific and medical research, which will in turn create more jobs.

But what the candidates are not acknowledging is that small businesses — a traditional engine of job creation in the United States — make up a shrinking percentage of total businesses, and they are not creating as many jobs as they once did.

There are now 28 million small businesses in the United States, but the number of jobs each establishment creates declined by 38 percent since the early 1990s, according to Census statistics. In 1994, each new business establishment created an average of 7.3 jobs in its first year versus 4.5 in 2015.

In a dramatic turnaround, now companies with 250 employees or more are creating more jobs than small firms, according to Department of Labor statistics. They contribute 45 percent of the net new jobs. In contrast, businesses with 1–49 employees contribute 34 percent, and those with 50–249 employees, 21 percent.

"The average number of employees has fallen without a doubt, and it's fallen the most for start-ups," said Steve King, partner in Emergent Research, a firm in Lafayette, California, that studies the independent workforce.

Statistics tell the story. In the past five years, the number of start-ups as a percentage of total firms in the United States hovered around 8 percent, Gallup discovered in a recent analysis of Census data, a study it conducted for CNBC. That was lower than the average of 12 percent in the past three decades. In the last five years, start-ups have added, on average, about 2.4 million jobs per year, compared to 3.04 million before the recession, Gallup found.

Cause and effect

Many factors are contributing to an environment that makes it hard for small-business owners to open up shop and create well-paying jobs, say experts and entrepreneurs. In a survey on small-business owners' top concerns in the election, released in February by online small-business lender OnDeck, 56.6 percent cited economic growth, 41.1 percent mentioned tax policy, 40.5 percent cited health-care costs, 24.2 percent said they are worried about new or changing regulations at the national and state level, and 21.8 percent are concerned about the strength of the skilled/educated workforce.

In another, recent survey by Spectrem Group, which provides research to help financial advisors understand investors, 74 percent of business owners said taxes are their greatest concern, followed by government gridlock and regulations. If there is a 10 percent increase in cumulative regulatory costs, the number of businesses with fewer than 20 workers dips by 5 percent to 6 percent, according to recent research by the American Action Forum, a right-leaning policy institute.

Financing has also gotten tighter. For the fourth quarter of 2015, venture capitalists invested $11.3 billion into 962 deals — the smallest dollar amount since the third quarter of 2014, according to the MoneyTree Report from PriceWaterhouseCoopers. The dollar amount declined 32 percent compared to the third quarter, and the number of deals was down 16 percent.

"Everyone talks about easy money, but capital is actually kind of hard to get," said Jackie Wu, 25, a former corporate consultant who now runs a robotics start-up in an incubator at Northwestern University and who recently launched a crowdfunding campaign on the site Indiegogo.

The rise of freelancers

Some small-business owners aren't hiring, because it has gotten easier to grow without doing so, thanks to automation and the freelance economy. For sole proprietors — who represent the vast majority of small businesses — contract labor costs accounted for 38 percent of total labor spending in 2013, up from 20 percent in 2003, according to figures released by the U.S. Census Bureau in 2015.

"This is a clear indication small businesses are using more contractors and fewer traditional employees," said Emergent's King.

Steven Lindner handles recruiting for a number of fast-growing small businesses as executive partner of The Workplace Group, a provider of outsourced and strategic recruiting solutions in the New York City area. Many of his clients are outsourcing work that would have been done in-house 20 years ago to outside experts, he said. For instance, few are hiring in-house accountants, HR professionals and in-house attorneys — and in-house marketing and advertising teams today are very lean. "You can outsource so many things," he said.

And as in the rest of the economy, many of the jobs that are being created are on the lower end of the wage scale. Frank Klesitz, the 30-year-old CEO and founder of Vyral Marketing in Omaha, Nebraska, grew his firm from 25 to 60 employees last year. He is being flooded with applications from debt-burdened college graduates for entry-level jobs, such as video editing, that pay $10 to $12 an hour, he said. These young workers can't find other good, local opportunities, he said.

Schools are not preparing students to understand that everyone is basically going to be their own business.
Frank Klesitz
CEO and founder, Vyral Marketing

Klesitz has found that many don't have the skills or mind-set to thrive in an increasingly freelance economy. "Schools are not preparing students to understand that everyone is basically going to be their own business," said Klesitz. "Kids are getting out of school, taking on all this debt, thinking they are going to get a stable job. That stable job does not exist anymore. Politicians should not be perpetuating that."

Presidential candidates: (L-R) Donald Trump, Hillary Clinton, Ted Cruz, Bernie Sanders and John Kasich
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Where the candidates stand

Candidates have issued broad proposals to help small businesses grow, but there has been little discussion about the complex factors slowing down the sector's job creation engine.

Trump has proposed a plan in which no business of any size will pay more than 15 percent of their business income in taxes. "Right now freelancers, sole proprietors, unincorporated small businesses and pass-through entities are taxed at the high personal income-tax rates. This treatment stifles small businesses. It also stifles tax reform because efforts to reduce loopholes and deductions available to the very rich and special interests end up hitting small businesses and job creators as well."

The Trump plan addresses this challenge head-on with a new business income-tax rate within the personal income-tax code that matches the 15 percent corporate tax rate to help these businesses, entrepreneurs and freelancers grow and prosper.

And to try to stop the movement of jobs abroad, he says he would impose a 20 percent tax on those who outsource jobs overseas.

Donald Trump to CNBC: US losing good jobs

Clinton has promised to create jobs by pushing for an infrastructure bank that would leverage public and private funds to invest in projects across the country. The Democratic front-runner has plans to invest $25 billion to support entrepreneurship in underserved communities in the United States. She has also promised to provide tax relief for small businesses that share profits with their employees. Her small-business agenda promises to "expand access to capital, provide tax relief, cut red tape and help small businesses bring their goods to new markets."

Meanwhile, Sanders has focused on investing in infrastructure to create jobs. His proposal, called the Rebuild America Act, would invest $1 trillion over five years to modernize our infrastructure and support more than 13 million jobs.

To promote job creation, Cruz has pushed for a business flat tax of 16 percent that he believes will spur capital investment and create 4.9 million new jobs . He is also pushing for the passage of the REINS Act, a law that would "hold Congress accountable to vote on any major cost-inducing regulation," he says on his site. He has also promoted policies that would keep the Internet from being heavily regulated, opposing the Internet sales tax, which he says would hurt small business.

To create jobs, Ohio's Republican Gov. John Kasich says on his website that he will support lower taxes for job creators and do a comprehensive review of federal policy to identify and eliminate barriers to research, innovation, commercialization of new breakthroughs and "start-up business success."

The big question is whether any of these candidates' plans can actually reverse the powerful trend toward leaner businesses — one that is fueled not just by the current economic climate but by advances in technology and automation.

While most efforts to encourage entrepreneurship focus on creating high-growth start-ups, some experts are asking if more should also be done to support the millions of ultra-lean microbusinesses springing up in the freelance economy.

"Is it a lack of success if we end up with 20 five-person companies rather than five 20-person companies?" asked Jonathan Ortmans, a senior fellow at the Ewing Marion Kauffman Foundation, which promotes entrepreneurship.

Ortmans and other experts say it is important to support measures to create small businesses of every stripe. "That requires we make a very aggressive and concerted effort to take away the hurdles in the way of entrepreneurial activity," says Sangeeta Bharadwaj-Badal, principal scientist, entrepreneurship at Gallup.

Small-business experts all agree: It's a worrisome trend that needs a national discussion.

— By Elaine Pofeldt, special to CNBC.com

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