Is small beautiful? Why implementation of electoral promises would prevent Polish SME from growing

This summer in Poland is busy with pre-election proposals and announcements.

 
Piotr Lewandowski

On 2th of July the Civic Development Forum (FOR), a think-tank founded by Leszek Balcerowicz, published its ideas on how to prevent the abuse of civil law contracts in Poland. On 4th of July the Law and Justice party (PiS) presented its economic agenda, while on 8th of July it was the turn of the governing Civic Platform (PO) party to showcase its ideas in the media. One may get an impression that all parties, regardless of their colours, have unanimously agreed on some issues – especially on increasing the tax-free income threshold or tax deductible expense in personal income tax. Another such issue is the need to make life easier for small companies, manifested in ideas put forward by both (pro free-market) FOR and (pro state interventionism) PiS, though in different form. FOR suggested exempting employers hiring fewer than 20 persons from the obligation to give any grounds for termination of an open-ended employment contract. PiS advocated the introduction of a 15 per cent corporate income tax for small businesses. The Civic Platform preferred to use corporate income tax to discourage employers from hiring staff on the basis of civil law contracts and proposed to reduce the corporate income tax in exchange for offering jobs under open-ended contracts.

Let us leave aside the fact that the right to dismiss a person without giving any grounds in companies hiring up to 20 employees would be equivalent to discriminating employees of such companies as opposed to employees who perform identical jobs in companies hiring 20 or more persons. Let us not dwell on the fact that, unlike VAT and personal income tax (especially those paid by low earners), the corporate income tax rate in Poland is lower than the European average and has not been increased in recent years – unlike VAT and personal income tax (effective tax rate, including tax thresholds). Let us not try to investigate how setting a corporate income tax rate on the basis of the type of contracts used in a given company may contribute to making the tax system easier to navigate and less time consuming for firms. Instead let us ask ourselves whether it makes sense to apply such powerful tools as diversifying the conditions of dismissing employees or lower corporate income tax to micro-enterprises.

According to Eurostat, relatively more people (43%) in Poland are employed in companies hiring 20 persons or less than on the average in the European Union (39%). This results from commonly used self-employment and a high share of persons working in companies employing up to 10 employees, which amounts to 37 per cent in Poland as opposed to 30 per cent on average in the EU. However, according to Eurostat, microenterprises employing 10 to 20 employees create only 5% of jobs in Poland, whereas the EU average is 9%. Companies employing between 20 and 50 employees also have a lower share in total employment than the EU average (26% as compared to 28%). Thus the most distinctive characteristic of Poland is the high percentage of really small enterprises, hiring no more than 10 employees. This is a considerable group of employers, so from a political or PR perspective one may understand the nudges and winks sent in their direction. Yet does the preferential treatment proposed by FOR and PiS make sense from the economic point of view?

There are various benefits to small companies, such as the fact that they are usually responsible for creating a large share of new jobs. Yet they are not without faults: research for OECD countries shows that compared to medium-sized and large enterprises, they are usually less efficient, less technologically advanced and more susceptible to external shocks, e.g. caused by foreign competitors (van Ark and Monnikhof, 1996, Size Distribution of Output and Employment: A Data Set for Manufacturing Industries in Five OECD Countries, 1960s-1990, OECD Economics Department Working Papers, No. 166; OECD, 1997, Small Business, Job Creation and Growth: Facts, Obstacles and Best Practices). The inability to grow, compete on international markets and improve efficiency in small enterprises is one of the reasons behind long-term economic stagnation in Italy, which largely relies on microenterprises (Pellegrino and Zingales, 2014, Diagnosing the Italian disease). Research shows that one of the causes of this inability is the long-standing differentiation enshrined in the Labour Code and regulations for small and larger companies: once the employment threshold (in Italy: 15 employees) is exceeded, new requirements apply, concerning not only newly-employed workers, but also amending requirements concerning previously employed ones (Garibaldi, Pacelli, and Borgarello, 2003, Employment Protection Legislation and the Size of Firms, IZA Discussion Paper No. 787). In view of the above, only very few companies with very good growth perspectives cross this threshold. Those that would have been growing gradually in different conditions prefer to preventively remain below the threshold and keep receiving preferential treatment – employing fewer people and paying them less than if they had grown. In France, companies avoid exceeding the 50 employees threshold and related additional burdens, such as the obligation to establish employee councils, growing entitlements of trade unions and more stringent conditions for redundancy (Gourio and Roys, 2014, Size‐dependent regulations, firm size distribution, and reallocation, Quantitative Economics, Econometric Society, vol. 5.). This translates into lower efficiency and competitiveness of the economy, while larger enterprises are indirectly protected against potential emerging rivals.

Poland already has regulations in place concerning companies hiring over 20 employees: once the company employs more than 20 people, the employer has the obligation to establish additional workplace and remuneration regulations. Several bureaucratic requirements listed in the Labour Code, which make sense in large organisations, but not necessarily in small ones (e.g. the obligation to prepare holiday leave plans for the entire year in advance), could possibly be abolished still. However, such concessions should not refer to the principles of employing or dismissing workers, not to mention taxation varying based on company size. In light of the Italian and French experience, addressing such strong preference as proposed by FOR or PiS to small companies would be a step towards preserving the dispersed structure of Polish companies. It would facilitate their existence and sentence them to an inefficient, low-paid, “little stabilisation”.