What role do small businesses play in the economy?

Entrepreneurship in the US declined in the four decades before the pandemic. Between 1998 and 2014, the share of Gross Domestic Product (GDP) attributed to small businesses fell, while large businesses experienced faster growth.

But since 2020, there has been an increase in entrepreneurial activity.

According to data from the Small Business Administration (SBA), small businesses create two-thirds of new jobs, increased competition among businesses, and are often the forces behind innovation and positive adjustments in efficiency.

How does the government define entrepreneurship and small businesses?

Depending on the industry, the Small Business Administration (SBA) classifies a small business based on either employee size or annual receipts. For example, a department store that earns up to $40 million in gross receipts annually is considered a small business, as is a winery that employs 1,000 people or fewer.

The government tracks the rate of entrepreneurship by the number of applications people submit to the IRS for employer or tax identification numbers. This can be a signal that an entrepreneur is officially starting a new business. And because new businesses generally start small, tracking these applications indicates how many new small businesses are forming.

How much has entrepreneurship increased?

The US Census Bureau tracks a range of business formation statistics that can be filtered by date and sector or by other factors such as state and county.

At the start of the pandemic, incoming applications for employer or tax identification numbers declined from 2019. Applications for tax IDs rose throughout 2020, ultimately growing by 900,000 applications — from 3.5 million to 4.4 million year over year.

For context, between 2010 and 2019, the annual average increase in the number of applications was 122,000. The application growth in 2020 was nearly seven times the typical average.

The number of applications has also remained higher since the pandemic. In 2021, they continued to grow, hitting 5.4 million before tapering to about 5.1 million in 2022. Looking at submissions on a monthly basis from 2012 to 2019, there were roughly 200,000 to 300,000 applications submitted each month. At one point in 2020, they shot up over 500,000. Since 2021, monthly applications have remained between 400,000 and 500,000.

There is a subcategory of business applications called “high-propensity” applications. This specifically refers to businesses with a high likelihood of having a payroll, meaning the business plans to hire employees and pay wages.

According to data collected by the Census Bureau, high-propensity business applications fell from 112,052 in December 2019 to 76,644 in April 2020, when COVID-19 halted many business operations. High-propensity applications rebounded in July 2020, peaking at 174,685. Applications have decreased since then, hitting 149,785 in August 2023.

Numerous economic forces in 2020 caused businesses to close and prompted others to open, creating noticeable anomalies in the data. But in 2023, both general and high-propensity applications remain higher than pre-COVID levels.

How do small businesses impact the economy?

Large businesses grew faster and accounted for the majority of GDP between 1998 and 2014, according to a summary of research on small businesses and GDP from the SBA. While small businesses’ share of GDP fell during this time, small businesses still accounted for 43.5% of economic activity in the US in 2014.

“Entrepreneurship plays an important role in allocating resources more efficiently throughout the economy, thereby making it more productive,” according to the Congressional Budget Office. And when new businesses operate more efficiently, they generate competitive pressure on existing businesses to innovate.

Though there are ways to innovate without needing a patent, patent application data is one way the government measures innovation. Overall, about 650,000 patent applications were submitted annually between 2016 and 2020.

An SBA brief on patent applications and business size shows that small businesses applied for 29,583 patents in 2018 and received 12,837. Large businesses have a higher patent approval rate (three per 1,000 employees) compared to small businesses (2.7 per 1,000).

But as a business grows, the number of patent applications per employee generally decreases. Businesses with one to four employees applied for about 270 patents per 1,000 employees — almost 25 times the rate of any other business size and more than 50 times the rate of large businesses.

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