What Happens When Startups And Small Businesses Are Taken For Granted

(Recent Census Bureau data show new business startups in California increasingly reluctant to hire other workers, given the costs and risks—the result of years in which state government piled costs and requirements on these startups and small businesses.)

I can still recall the excitement among community economic development professionals in the early 1980s, regarding new business startups and their job creation power. Groundbreaking research at the time by Massachusetts Institute of Technology professor David Birch revealed that contrary to prevailing wisdom, most new jobs were being generated not by the large and established employers, but by new and small businesses. Economic development strategy began to move away from the traditional attracting and retaining large businesses, to strategies for fostering startups and small businesses.

During the pandemic business startup rates showed a surprising and encouraging increase, and these rates have continued to be high in the post pandemic period. This has been true in California as in other states. Yet, recent Census Bureau data are showing a new phenomenon in California. Fewer and fewer new businesses say they plan to hire other workers. These startups are deciding they can’t risk the costs and potential lawsuits that come now with hiring in the state.

The Latest Data on Business Start Ups and Planned Hiring

The Census Bureau maintains a “Business Formation Statistics” data set to track start-ups. It draws primarily from applications made to the Internal Revenue Service for a new Employment Identification Number (EIN). Startups are at near all-time highs in the post pandemic period, with over 2.7 million applications for an EIN filed in the first six months of 2023. As Daniel Newman of the Economic Innovation Group notes in a recent posting, these applications represented a 52% increase over the same period in 2019, prior to the pandemic.

Mike Kahoe is the chief economist with California Center for Jobs and the Economy, who for years has carefully tracked data on California business growth. Drawing on the most recent Census data through August 2023, he prepared the chart below, showing the unanticipated increase in applications during and after the pandemic.

The Census Bureau also maintains a data series on “Business Applications with Planned Wages”, identifying businesses that say they plan to hire other workers. Kahoe also has tracked this series through the most recent period of August 2023, and the results are shown in the chart below. The percentage of business start ups saying they plan to hire other workers has declined sharply since the early 2000s and has continued to be low in the pandemic and post pandemic time.

The Vast Edifice of Employment Regulations and Penalties

As Kahoe notes, it is not difficult to determine why this reluctance to hire is occurring. Over the past two decades in the state, a vast edifice of regulations and penalties have been enacted by the state legislature related to employment. A new business or small business that takes on a worker does so now in an environment in which the slightest technical violation of the extensive wage and hour regulations can result in significant liability.

Perhaps no better example exists of the environment facing employers today than the use and misuse of the state’s Private Attorney Generals Act (PAGA). PAGA was enacted by the state legislature in 2004, to try to improve the process by which a worker might recover wages unlawfully withheld by an employer. The existing process required the filing of a complaint to the state’s Division of Labor Standards Enforcement (DLSE) and an investigation by the Division. Worker advocates complained that the complaint process was slow and DLSE couldn’t handle its growing claims backlog.

In response, PAGA allowed workers to go directly to court and sue their employer for penalties based on a range of state labor code violations. It provided for a single worker to file an action on behalf of other “aggrieved” workers (without the class certification requirement of other class actions) and also on behalf of the state for civil penalties. It incentivized attorneys to take up these cases by providing for attorney fees and court costs, which could be in the tens and even hundreds of thousands of dollars.

The result could have been predicted. The Act meant to help workers became hijacked by plaintiff attorneys, who could file actions and threaten costs of litigation. For the past decade, it has become often less expensive for employers to settle frivolous cases than to go through litigation.

While costs to employers have soared, only a tiny percentage of the settlement money has found its way into the pockets of workers. A major study released in 2021 by Christine Baker and Len Welsh analyzed data on PAGA cases filed between between 2013 and 2018. An average of 2000 cases per year were filed during this period. Among these PAGA cases, the average attorney fee was $405,724 and the average litigation fee an additional $23,604. In contrast, the average original award to the worker was around $12,828.

Small and large employers in the state have been making plans to challenge PAGA with a ballot measure in 2024, and replace it with a process that more fully benefits workers for any wage violations. But the measure will be difficult to pass, given the power that the plaintiff attorney associations wield in state government.

And even if PAGA is altered, there remain the hundreds of other regulations and penalties that can trip up employers, and that rarely benefit workers to any significant effect. The most recent legislative session that ended in September brought a new batch of employment regulations.

Taking Startups and Small Businesses For Granted

Kahoe and the California Center for Jobs and the Economy are involved in several projects with the goal of improving the economic situation of California’s lower wage workforces. As part of this effort, the Center has held a series of focus groups with these workforces. “One surprise of the focus groups has been how many of the workers say they want to start their own businesses,” Kahoe explains. “In spite of all the challenges, a large number still saw starting their own business as the best path for upward mobility.”

Whether or not entrepreneurship and its challenges is the right fit for a lower income worker who is struggling to get by, will depend on the individual situation. In all cases, though, the hiring environment in the state is making more difficult the addition of workers beyond the entrepreneur themselves.

Kahoe notes that the current hiring environment not only undermines the job creation dynamics that have propelled the California economy in the past. It also undermines the asset generation impact of the businesses. “On an individual level, starting a business with employees creates an asset that can be sold or handed over to your children, while businesses centered around one person are more of a practice that lives and dies with the person operating it.”

A lot has changed since the entrepreneurship and small business emphasis of the early 1980s. Over time in California, entrepreneurs and small businesses came to be taken for granted, their contributions downplayed, more and more regulations and penalties piled on by state government. The Democratic legislators who tightly control the state legislature regularly pay lip service to small business, but no more than that.

Perhaps the latest Census Bureau data will spur a wider discussion on how far California government (and certain other states) have strayed from the truths of job creation. Some wake up call is needed.