In 2008, the average sole proprietor’s net income was approximately $12,000. Such low earnings beg the question: Why aren’t sole proprietors’ making much money?
At first glance the Great Recession appears responsible. IRS data show that the net income of the average filer of a schedule C fell more than a seven percent in real terms in the first year of the economic downturn (2009 data are not yet available).
While this drop clearly shows the negative effect of the recession on small business owners’ earnings – 72 percent of whom run sole proprietorships – the Great Recession isn’t the primary cause of the proprietors’ falling income. That’s because the drop in income started well before the recession got underway. IRS data show that 2008 was the third year in a row that average sole proprietor net income declined in real dollar terms. In fact, as the figure below shows, the average income of sole proprietors (in 2007 dollars) has been trending down since the late 1980s.
The decline in sole proprietors’ earnings doesn’t reflect a long term decrease in the earnings U.S. companies. IRS data indicate that the net income of the average American business increased 48 percent in real terms between 1980 and 2007.
Moreover, the average subchapter S corporation and the average partnership experienced large increases in income from 1980 to 2007. As the figure below shows, over past 28 years, the average partnership has seen a 1,365 percent rise in income in real terms and the average subchapter S corporation has experienced a 763 percent increase, while the average sole proprietorship has faced a 22 percent decline in real income.
So what accounts for the long term decline in average earnings of sole proprietors? It can’t be shrinking margins, which have actually increased over the last three decades. Back in 1980, sole proprietors had an average margin of 13 percent, well below the 21 percent average in 2007.
Instead, the data point to shrinking sales. Measured in constant dollars, revenues at the average sole proprietorship were 51 percent lower in 2007 than they were 1980.
But this decline in sales was only experienced by sole proprietorships, and not by small businesses taking other legal forms. Between 1980 and 2007, average revenues increased 157 percent at partnerships and 57 percent at S corporations when measured in real terms.
Why did the average sole proprietorship (but not the average S Corp or partnership) experience a drop in sales over the past three decades? The data suggest a rise in part-time business ownership. Between 1980 and 2008, the number of sole proprietorships per capita almost doubled, indicating a big increase in the proportion of Americans that files a schedule C. However, the share of the labor force that is primarily self-employed fell almost a full percentage point over the same period. If more of the population is filing schedule C’s, but less of it is primarily self-employed, then we must have more people running businesses on the side than we used to.
In short, the data suggest that the falling income of the average sole proprietor results less from the Great Recession than from a long-term decline in average revenues. This revenue slide, in turn, likely comes from a change in the composition of sole proprietorships. As the share of filers of schedule Cs running side businesses has increased, the performance of the average sole proprietorship has declined.