Small businesses already slipping off the 'cliff'

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NEW YORK – More than 1,000 miles from Washington, D.C., Marie DeNicola's small business is already experiencing the consequences of lawmakers' inability to compromise on the budget.

If Democrats and Republicans don't come to a consensus soon, a combination of billions of dollars in tax increases and budget cuts will go into effect Jan. 1. This "fiscal cliff," as it is commonly being called, is already hurting DeNicola's company Mainstream Boutique, a Minneapolis-based chain of 23 franchise stores that sell women's clothes. DeNicola recently got a painful e-mail from a prospective franchisee who said that she changed her mind about opening a store because of uncertainty about the economic and political climate.

"It was like a punch in the stomach," says DeNicola, who also operates one of the stores. "It's a little scary — because of the unknown, small businesses aren't waiting until January or February to see what happens. People are reacting now."

Going over the cliff could have a range of negative ramifications. If people have to pay higher taxes, they will likely spend less. Businesses will hold off on hiring or making investments that could help them expand. Federal budget cuts will put billions in government contracts in jeopardy. Economists and lawmakers warn that without an agreement, the U.S. could slip back into a recession. And they say that small businesses have the most to lose.

Like her potential franchisee, DeNicola is also holding off on big moves because of the cliff.

"We're waiting to see what happens before we decide on hiring. I can't continue to invest in the business until I know what's going to happen," she says.

One of the biggest concerns for small merchants is the pending expiration of the 2 percentage point cut in payroll taxes that gave consumers more money to spend in 2010 and 2011. If the tax cut isn't extended, the government stands to get $95 billion — money that consumers won't be spending at Mainstream Boutique and other small businesses. Long-term jobless benefits will also expire, giving people who have been out of work for a long time $26 billion less to spend.

The prospect of consumers spending less troubles Greg Jones. The owner of three Five Guys Burgers and Fries franchises in Florida is concerned that customers who might normally stop in three times a week will cut that back to once. Restaurants like his lost business to cheaper options like McDonald's during the recession. He's worried that will happen again. Jones wants to open two more Five Guys locations, but says he might not be able to if the country goes over the cliff. If his existing restaurants aren't profitable enough, he won't get the money he needs to expand.

The consequences that Jones faces are a big part of why Georgia Institute of Technology professor Thomas Boston says he thinks the fiscal cliff could do enough damage to small businesses to halt the economic recovery.

"They're just now recovering, really growing in any kind of significant way since the recession," Boston says. "The job creation we've seen over the last five months, that creation has been located overwhelmingly in small businesses."

The stalemate in Washington has kept Arthur Cooper from making big decisions about his Randolph, N.J. Internet marketing company, Optimum7.

"I have to be more defensive in my posture — I have to hire only based on new business that's already coming in," he says. "I can't plan on news business that might happen."

Like many small business owners, one of Cooper's concerns is the scheduled increase in personal tax rates. He reports his business income on his personal Form 1040 tax return. The scheduled tax increases could result in a much higher tax bill.

"Let's say I'm going to have to pay $30,000 more for next year in terms of taxes than I did this year," Cooper says. "What impacts me personally impacts my business."

Cooper expects Congress to do what it has done many times in the past — come up with a stopgap measure and defer significant decisions until six months or more into the future. That would keep him in limbo while he waits to see if lawmakers will eventually agree on taxes and a budget. He's angry about what's happening in Washington.

"It's an embarrassment to the country. It's an insult to my intelligence," he says.

During the presidential campaign, Republican candidate Mitt Romney contended that small business owners would be hit so hard by the scheduled increase in the top tax rate — a jump from 35 percent to 39.6 percent — that they'd stop creating jobs. That rate would affect single taxpayers who earn $200,000 or more and households that earn $250,000 or more. But Democrats and advocacy groups including Small Business Majority say the number of business owners who would be affected by that increase is less than 5 percent.

"This is a myth that just continues to get life without any substantiation," says Rep. Gwen Moore, D-Wis. She says the bigger issues are the 2 percent payroll tax cut and unemployment insurance extension. If they're allowed to die, she says, businesses like Jones' Five Guys franchises will suffer.

"That's the bottom line — how many people are going to be out eating those burgers and fries," she says.

Edna Abernathy, who owns two businesses in Moore's district in Waukesha, is also concerned about the payroll tax cut because of the impact it will have on her staff. If it disappears, workers will end up paying as much as extra $2,000 to the government, essentially giving them a pay cut. Abernathy says she will try to replace the lost money for her employees at E.R. Abernathy Industrial Inc., which sells janitorial, safety and other supplies to other businesses, and Abernathy Consulting Ltd., an information technology consulting firm.

"We're going to have to try to make it up with more business, and we are looking at that as we prepare for the new year in terms of marketing strategies — how can we go after more market share?" she says.

She's looking toward 2013 with some trepidation, because she says many of her clients, which include companies in the Fortune 500, have been cutting back. "It's disheartening. Normally we look at the new year with a lot of enthusiasm," Abernathy says.

Small business owners who rely on federal contracts are worried about how much business they'll get from the government if big spending cuts go into effect. Vince Fudzie, CEO of Triune, a general contracting company based in Dallas, says business with the government has been shrinking since 2006, and the cliff presents yet another challenge. He's already been waiting to find out if he'll get approval to finish a dormitory project for the Department of Labor that's 95 percent complete.

If no agreement is struck, Fudzie says he'll have to re-evaluate his business and see if it can find new niches to fill.

"Even in a bad economy, there are pockets that are doing better. We have to figure out, what are we good at?" he says.

In the meantime, he's frustrated by lawmakers' inability to reach a deal.

"We elect these seemingly reasonable people to go to Congress and they seem unwilling to get along," he says.

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