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.
On what level is income of $12,000 compared with other places in the world?
Seems to me that the increased presence of small, online businesses could be pulling the average down over time. Would bloggers with affiliate ads, AdSense or other advertising be included as sole proprietors?
Definitely lots to consider as a relatively new sole proprietor myself, it’s definitely a lot to take in.
Increasing regulation will drive out sole proprietors and small business and leave the field to big business that has the political connections and can afford the lawyers and accountants. There will be distinct business and government-dependent (including healthcare and education) classes of work/careers with very little social mobility between them, just as in Europe.
While more new and part time sole proprietorships will skew the percentages, there are other serious factors that are affecting small businesses and will hurt their earnings much more in the future.
ONE search engines controls 65-90% of both the free organic and paid pay per click advertising traffic and sales for most businesses that have an online presence. They have publicly stated and are rolling out specific “upgrades” that favor Big Brands (think Fortune 500) over all other forms of businesses.
Small online ecommerce etailers see their search engine traffic dropping because their positions in that search engine are dropping down – eventually off the first page (very bad news because most Internet users never look past that first page).
This is especially bad for those who sell commoditized products (products that are priced about the same and widely available from other small online stores) because dropping from first position into second on that type of products can decrease traffic and sales by an astonishing 70%!
Engraved gifts is a good example of that situation. Before May of last year they competed with other online engravable gift stores. Today, Amazon, OfficeMax and Staples appear above them for searches for their top selling engravable items. Do a search for “business card holders” to see that.
Small Businesses and bloggers must raise awareness with consumers. Help them understand how where they spend their money affects our economies. Every dollar they decide to spend with a small business creates a stronger economy and success for individuals while every dollar they spend with a Big Brand takes food off our tables and hands the wealthy elite more control. (There are statistics that clearly show this in my blog post linked to this comment.)
I have links and statistics to prove every point I have made in this comment. I did not include them because many blogs prohibit links in comments or delete comments with links and this is too important for small businesses and consumers alike.
Robert Brady mentioned affiliate marketing. There are new solutions that will automatically favor big brands in blogs and across affiliate marketing driven ecommerce sites. Small Businesses need to be aware of all these trends and get serious about using the Internet to increase their reach. Do it now while we still have net neutrality – and that is at risk.
Today all sites can load equally well without the site owner paying to make their site available. The Internet leveled the playing field for the few small businesses who understand how to continually improve what they do online. That could change as the wealthy elite seek to regain the control they once had (when they controlled all the media, television and radio stations) through creating a faster Internet (or the ability to reach mobile devices such as iPads, GPS systems and cell phones) available to only those with deep pockets willing to pay.
One day it might just take many times longer to download be able to get to my blog, or your favorite charity site or read about small business trends on any site that doesn’t have the resources to buy access to the “faster” Internet – or you might not be able to find us in “the” search engine at all.
Today there IS a solution – use indepedent alternatives and support small businesses. I have much more information on what small businesses and bloggers can do now. I encourage you to act now while we still have the most access and ability!
@Gail Gardner, government-controlled internet access – “net neutrality” – will only increase the power of Google and politically favored big business in general.
I can’t help how much the data is affected by noise like variations in tax code, tax policies, tax accounting. Profits are a somewhat fictional concept rooted in accounting and tax enforcement, not necessarily directly correlated with cash flow and owner/operator financial welfare. It’s what’s left over after costs and expenses. Owner/operator cash flow is quite often part of the expenses, rather than left as profits.
And I wonder what’s up with the partnerships. What I’ve heard for decades now is that partnerships have fallen out of favor, professional corporations and LLCs. Does having fewer of them, if that’s actually the case, affect this number? It doesn’t seem like it should, but still … very interesting post, thanks Shane.
This could be misleading. There have been many sole proprietors that take a “laugh test” income level between $12-40k, but take the rest of the income as dividends. With this approach the sole proprietor avoids the ~15% payroll and medicare taxes. This may not be the case, but just saying that there could be more to the picture.
Big difference between a sole proprietor that owns a brick and mortar store and one that does online sales or flea market sales on the weekend. When you lump part time sales in with full time businesses of course you are going to get lower averages. The advent of Ebay, and ETsy stores is just the tip of the iceburg. No one runs a full time business as their only income for $12,000 profit.
There are many factors that contribute to this. Commoditized products are increasingly hard because search engines can make or break sales.