Healthcare reform—that thousand-plus page monster that, according to House Judiciary Chairman John Conyers (D-MI), is pointless to read—is going to have a great and terrible impact on entrepreneurs and from that epicenter on their businesses, their employees and the economy as a whole. According to Columbia business professor Rita McGrath, the reason for this is that entrepreneurs will change the way they do things, not so much to thrive but to cope. She writes that “the plan currently being sped along by the House Democrats is going to fundamentally alter what [economist William J.] Baumol called the ‘structure of incentives’ that shape how entrepreneurs allocate their energies.”

The Structure of Incentives

What are these incentives? They are the things that make going into a particular business worthwhile. According to an article written by Baumol and entitled “Entrepreneurship: Productive, Unproductive and Destructive”, you get the kind of entrepreneurship that your culture encourages. Those places where risk-taking and productivity are rewarded encourage their entrepreneurs to pursue such courses. Where politics and status-seeking are encouraged, the drive and energy of entrepreneurs go in those directions. Finally, where corruption and criminality are rewarded, entrepreneurs will go in those directions as well. So, in the end, we have three different kinds of entrepreneurs: The productive, the non-productive and the destructive.

What worries McGrath is how American entrepreneurs will be forced to change by the policies coming out of the Obama White House. Up until now, America has been a bastion of the productive sort of entrepreneurial spirit. That is not to say that there is no crime and corruption, no politicking or status-seeking. There certainly is, but on the whole those elements are small when compared to the bulk of honest and productive enterprise. McGrath’s worry is that much of what is now productive will, in natural reaction to the confiscatory taxation schemes being pushed to fund Obama’s healthcare reform, be rendered unproductive as business owners seek to mitigate or dodge entirely the new tax burdens.

Small Business Reaction to Obama’s Healthcare Reform

If the structure of incentives is altered by Obama’s plan, then the outcome, in the form of entrepreneurial activity will, likewise, be altered; and according to McGrath, it will be altered for the worse. Citing a study of Sweden’s welfare state that shows key welfare state institutions reduce economic incentives both for opportunity-based and necessity entrepreneurship, she writes:

The first predictable consequence is that an awful lot of entrepreneurial energy is going to be spent, not productively, but unproductively, as small business people and those falling into the higher-tax categories spend their time not producing new innovations but figuring out how not to fall into the maws of increased tax and regulatory burdens. Following right on that as a predictable consequence is that those who are able to do so will do business in such a way that they don’t fall into the higher-taxed categories. Rather than pay individual rates, small businesses will incorporate and pay the lower 35% corporate rate.  Further, get ready for the new conglomerates - thousands of businesses employing exactly 24.5 people, all interconnectedly doing business with one another rather than falling foul of the over 25 employee [healthcare tax trigger] stricture. And with small business growth having led us out of most recessions in the past, get ready for this sector to add jobs far more slowly and with far greater caution than it had previously - a big blow to an economy that desperately needs a vibrant and growing small business sector. 

At a more macro level, a huge body of research points to the same conclusion (remarkably, for academic research). The effects of higher individual taxes on rates of entrepreneurship are without an exception, negative. It is well accepted, and has been for decades, that the desire to have a vibrant entrepreneurial economy is at odds with the desire to operate a welfare state, due in large part to the way in which welfare states allocate resources – when the upside to undertaking the risks of entrepreneurship decrease, while the downside of not doing much at all are limited, it becomes hard to justify making the effort. If it is possible to live quite a comfortable life without too much bother, why take on the long hours, the worry and the headaches of small business ownership?

The Bottom Line

This is just one expert’s take on the situation, but McGrath is not alone in sounding the alarm against this legislative cancer. A recent letter to the Wall Street Journal from a physician who owns a medical company said plainly that he would begin laying people off, beginning with everyone sporting an Obama bumper sticker on their car, since he cannot afford to pay more taxes and employ all the people he does.

It is because of research like McGrath’s, research into the costs and consequences of this kind of radical legislation, and the reaction of small business owners like this doctor—a reaction multiplied millions of times across the nation—that Obama and Pelosi want this over and done with before August, rushed through with no one reading, let alone comprehending, what they are voting for; rushed ahead so that by the time the members go back to their districts it would be too late for the people back home to complain and pressure them to not vote for the bill.

That tactic alone should give every small business owner who cares about his company, his family, his employees, a moment of pause. Mixed with what we know of their plan, it should also light a fire under them to pick up the phone and tell their representative not to bleed their businesses dry. You can find the numbers you need here, at House.gov and Senate.gov.