What PPP Round 2 Means for Your Small Business

Congress extended the Paycheck Protection Program as part of its economic relief bill finalized on Monday, allocating $284 billion to it. The changes to the PPP are a mixed bag: Some parts of the new bill will set the program back, while others will likely make it more effective. My expectation is that history will judge the program a success and that Congress was right to include a second round in its $900 billion relief package.

The new PPP “second draw” loans are very similar to those under the original plan, passed in March as part of the $1.8 trillion Cares Act. The second round will allow eligible small businesses to take out loans of up to $2 million that can be forgiven — essentially, converted into grants — if businesses meet certain conditions, including attempting to avoid layoffs and wage cuts, and if funds are used on payroll and other variable costs.

There are problems with three aspects of the current version.

First, the bill allows companies to deduct expenses financed by the PPP. For example, a business that paid its electric bill using a grant from the program can deduct the cost of that bill from its taxes. But since the business didn’t pay the expense out of earned revenue, it shouldn’t be deductible.

The second mistake is that eligibility for “second draw” loans is restricted to companies that experienced at least a 25% reduction in gross revenue in one quarter in 2020 relative to the same quarter in 2019. This focuses loans on businesses that have been hardest hit, which many will interpret as a feature, not a bug. But it will also give preference to businesses that are the more likely to fail, making the program less effective by not putting funds to their best use.

Third, the program should do more to help the economy adapt to post-virus realities. Instead, it remains too intent on preserving the pre-virus economy. For full loan forgiveness, businesses still must spend at least 60% of PPP funds on payroll costs. But it would be better if the focus was more on replacing lost revenue, and allowing businesses the flexibility to adapt the size of their workforces to their post-pandemic needs.

The new round of the PPP allows restaurants to receive loans equal to 3.5 times their average monthly payroll costs, while businesses in other industries are restricted to loans of 2.5 times payroll expenses. Restaurants have been hurting, of course. But if consumers are going to want to eat out less in the post-virus economy, the government shouldn’t attempt to interfere by giving restaurants special treatment.

Even given these flaws, extending the Paycheck Protection Program was the right thing to do. My research with economist Glenn Hubbard shows that it supported employment and improved the financial health of eligible business over the spring and summer, with the strength of its positive effects growing over time. We also found some evidence that the program kept businesses from closing their doors. I expect that the new round will have similar effects.

Despite indications that the PPP was working over the spring and summer, the jury is still out on its ultimate success. While the program was widely touted as a way to preserve jobs — a goal it likely met through at least August — it also has two other important objectives.

The first is to preserve the productive capacity of the small-business sector by preventing a wave of pandemic-related bankruptcies. Small businesses possess a lot of knowledge about their neighborhoods and customers, and have valuable relationships not just with employees, but also with suppliers, customers and other local institutions. If these companies were not passing the market test, then losing these networks and this capital would not necessarily be wasteful. But losing it because businesses couldn’t weather a pandemic would be.

The second goal is to quicken the pace of the economic recovery by supporting labor demand as the vaccine is distributed. If the program prevents businesses from permanently closing, then the unemployment rate can come down faster because laid-off workers won’t need to wait for new businesses to form in order to find jobs.

Supporting small businesses has been the right thing to do during the pandemic. But once the vaccine is in wide distribution, the government should not prop up these companies. They will need to sink or swim on their own.

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