Report

American Enterprise Institute

Key Points

The Paycheck Protection Program (PPP) provides forgivable loans to small and midsize firms. It is a bold new policy to preserve businesses and employment relationships and to provide government financial assistance to workers during the COVID-19 economic shutdown.

However, three problems in the legislation and its implementation will blunt PPP’s economic effectiveness: insufficient support for non-payroll costs, implementation challenges by the Treasury Department and the Small Business Administration, and inadequate funding.

We recommend three avenues of reform for PPP. First, the program should fund more non-payroll costs. Second, lenders should receive sufficient assurances that they will not be held responsible if borrowers misrepresent themselves. Finally, Congress should fund the program at a level commensurate with expected demand, so borrowers are not discouraged from applying.

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Introduction

The Coronavirus Aid, Relief, and Economic Security (CARES) Act program to provide forgivable loans to small and midsize firms is a bold new policy direction to preserve businesses and employment relationships and provide government financial assistance to workers during the pandemic’s economic shutdown. But design and implementation concerns blunt, or even threaten, the program’s success.

Before the passage of the CARES Act, we wrote our proposal1 for aid to small and midsize firms out of concerns for the particular financial exposure those businesses—and their workers—face during an economic shutdown associated with fighting the spread of the COVID-19 virus. As we observed:

Stabilizing infection rates and present conditional mortality rates through health policy actions can yield health and mortality consequences of the COVID-19 pandemic not as large or long-lasting as many fear. But there’s an economic catch: The very policies (social distancing, no mass gatherings, closure of many businesses, etc.) to make the infection curve less steep will steepen demand shortfalls and recession losses. . . . To stop the [aggregate demand] doom loop in its tracks, the federal government would need to make up a large fraction of this demand for a short period of time while the slope of the infection curve flattens (second derivative) then stabilizes (first derivative). To receive this support, firms would be required not to lay off workers during the period.2

Our proposal essentially envisioned grants to businesses to recover all or a significant portion of revenue over a defined period (e.g., 12 weeks). The grant would be administered as a forgivable loan made though a bank, with forgiveness conditional on not laying off workers. The actual Paycheck Protection Program (PPP) authorized by the CARES Act determined loan size based on payroll, not revenue, but allowed for loan forgiveness if funds were spent on payroll, rent, utilities, and mortgage interest.

Three problems in the legislation and its implementation will blunt the economic effectiveness of this important program to mitigate mass business closures and layoffs by small and midsize firms: inadequate funding, insufficient support for non-payroll costs, and implementation challenges by the Treasury Department and the Small Business Administration.

Inadequate Funding

We estimated that full revenue replacement for nonfinancial small businesses in the services sector for 12 weeks would require $1.5 trillion. The actual program that Congress created forgives payroll, mortgage interest, rent, and utilities payments for an eight-week period. Congress appropriated $349 billion. This appropriation was insufficient.

As of April 13, less than two weeks after the program was launched, 4,664 banks had approved 1.04 million PPP loans, lending $247.5 billion to borrowers.3 The program will likely run out of money in mid-April.

Treasury regulations specifically stated that funds would be disbursed on a first-come, first-served basis. The perception that limited funding would run out quickly has likely discouraged many true mom-and-pop shops from applying for a PPP forgivable loan and may have concentrated lending to borrowers with access to more sophisticated financial advice.

Non-Payroll Costs

Our original proposal focused on maintaining business revenue for nonfinancial small and midsize businesses in the service sectors. We did so because business continuity requires attention to those businesses’ fixed obligations, including rent, utilities, and interest payments. More recently, Samuel G. Hanson et al.4 noted the importance of non-payroll components of revenue and argue for lending against those obligations (with amounts to be determined from federal income tax returns). In our view, those loans could, in principle, occur under a revised version of the CARES Act program (as a grant) or as a loan (as in Hanson et al.) through the Federal Reserve Main Street Lending Facility, once it commences operation.

Regulations from the Treasury Department and Small Business Administration focused PPP on payroll, requiring that payroll constitute at least 75 percent of the amount of the loan that would be forgiven. This requirement (which is not found in the statute) creates suboptimal outcomes. Businesses in high-rent cities, for example, lose out on a significant amount of loan forgiveness, as do businesses whose other non-payroll expenses are significant. When appropriating additional funding to PPP, Congress could remove this regulatory requirement.

Implementation Challenges

Implementation of the PPP has been rocky, owing to early missteps by the Treasury Department and the Small Business Administration about both lender responsibility and terms of eligibility. For lenders, the Treasury Department was slow to clarify banks’ verification roles and requirements for anti-money-laundering and know-your-customer rules. Borrowers faced definition questions of who was eligible and how to apply, technical problems with applications, and concerns over loans with forgiveness tied only to payroll. Lender concerns have been addressed better (though some concerns remain); borrowers still face a thicket of unclear guidance.

Regulatory guidance for banks has encouraged them to focus lending on existing customers out of concern that lending to new customers would be slower or would result in exposure to penalties and enforcement actions if borrowers misrepresent themselves on their applications. (This regulatory requirement seems contrary to our reading of the statute’s intent.) This puts true mom-and-pop shops at a disadvantage if they do not have a preexisting banking relationship with a lender participating in PPP.

Real Concerns

These concerns and suggestions to think about a revised PPP in revised legislation are not just general ones. Many individual small business owners have written us to express frustration with byzantine regulations and guidance from the Treasury Department and the Small Business Administration. Particularly problematic in those letters are the limits on loan forgiveness for non-payroll items, a point we raised in our initial proposal and that Hanson et al. subsequently advanced.

More systematically, Alexander W. Bartik et al.5 surveyed 5,800 small businesses, documenting their general fragility, closures and layoffs, and trouble accessing PPP assistance under the Treasury and Small Business Administration guidance. Some respondents did not trust that the federal government would forgive the debt (suggesting the need for better communication to enhance awareness), while others complained about application hassle and complex eligibility rules. The good news is that most potential small business borrowers would like to participate and view the grants as helping forestall employee layoffs and business closures.

Reforming Small Business Recovery

Refocusing the lending and grant program for small and midsize firms on revenue more broadly and not just payroll could occur through three avenues of reform in design. First, the program should fund loans or grants to cover more of total revenue, increasing the chance for business flexibility, continuity, and survival. Second, lenders should receive sufficient assurances that they will not be held responsible for borrower misrepresentations. Finally, Congress should fund the program at a level commensurate with expected demand, so discouraged borrowers do not simply fail to apply.

Fixing the PPP’s design and implementation should remain a crucial objective for policymakers. The Federal Reserve will not rescue flaws in design and errors in implementation. Despite the Fed’s use of the name “Main Street Lending Facility,” its program almost surely addressed businesses with 500–10,000 employees (evidenced by the facility’s modest capital and $1 million minimum for loans).

Congress’ approach for small and midsize business financing in the CARES Act emphasizes the importance of business and employment continuity over simply allowing mass failures and layoffs and relying on unemployment insurance to address them. This is the right approach, and reforming PPP can increase its effectiveness.

Notes