November 28, 2014

How Much Will the Sequester Cost Small Business Contractors?

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The sequester is here.

Over the next seven months, federal agencies need to trim their budgets by $85 billion. How much will this budget cutting exercise cost small business contractors?

Coming up with a precise estimate isn’t easy. Only some of the federal budget cuts will come from spending on outside contractors. And the cuts to contracts will be borne mostly by big businesses since that’s who gets most of the federal contracting dollars. More importantly, only some of these budget cuts will affect cash disbursements.

My first thought was to look at the numbers coming out of Washington. But after examining several of them, I am convinced that they aren’t plausible, perhaps because they are politically motivated. For example, the Democrats on the House Small Business Committee released a report estimating that small companies will lose $7.6 billion worth of federal contracts because of the sequester. That’s a whopping 18 percent of what the non-partisan Congressional Budget Office (CBO) estimates will be the decline in total federal cash disbursements this year.

My calculations – imprecise as they are – suggest that the effect on small business revenues will be much smaller for three reasons.

First, the federal government will only cut this year’s cash disbursements by half of the amount that budgets will be trimmed. As the CBO explains:

The $85 billion represents the reduction in budgetary resources available to government agencies this year as a result of the sequestration. But not all of that money would have been spent in this fiscal year in the absence of the sequestration: Some would have been used to enter into contracts to buy goods or services to be provided and paid for next year or in subsequent years.

Second, contracting accounts for only about 15 percent of federal spending, numbers from a recent CNBC report suggest. Slicing 15 percent from the $42 billion in cash disbursements amounts to only $6.3 billion cut from federal contractors.

While agency directors might prefer to cut contracting by more, their hands are tied. Not only do federal officials lack discretion when it comes to making cuts under the sequester, but also much of what is being spent this year was contractually agreed upon in previous years.

Third, most federal contracting dollars go to big companies. In 2011 – the latest year data are available – only about 22 percent of the money Washington paid to contractors went to small businesses, the Small Business Administration reports. Assuming small and big business contractors take a proportional hit to their revenues, small business contractors will take in about $1.4 billion less in revenue this year.

That’s not a lot. It’s approximately 0.1 percent of the small business sector’s annual revenues, given the latest Census Bureau revenue estimates.

If you are a small business owner whose business relies heavily on small business contracting, the sequester will hurt your revenues. But for the small business sector overall, the sequester’s impact on revenues will be slight.

5 Comments ▼

Scott Shane


Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

5 Reactions

  1. Thanks for the update Scott. I hope it’s something you keep following. As a country, we have to have a more responsible government, so in the long run some cuts will hurt other small businesses, but if spending overall is kept rational, we all will be helped.

  2. The impact will probably affect small businesses around military facilities more…both positively, and negatively. For instance, when Navy units in Norfolk don’t deploy, that means more Sailors in town spending money. But in a place like Key West where the majority of the military presence is training, the area will lose training units and thus income flowing into town that way.

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