If Congress must have revenue tests, make them backward looking

began negotiating in earnest this week on the details of “Phase 4,” the next
round of economic recovery legislation to address the fallout from the
coronavirus. Legislators are feeling pressure to make modifications to the
Paycheck Protection Program so that funds are better targeted on businesses
most in need.

There is growing support for revenue tests in the Senate, along the lines of what Treasury Secretary Steven Mnuchin called for last week: “This time we need to have a revenue test and making sure money is going to businesses that have significant revenue declines.”

disagree with the secretary. A forward-looking revenue test is a success tax
that should be avoided. A revenue test would slow the recovery of the
small-business sector, hurting the sector overall and the workers it employs.

U.S. Treasury Secretary Stephen Mnuchin and White House Chief of Staff Mark Meadows attend a meeting to discuss legislation for additional coronavirus aid in the Oval Office at the White House in Washington, U.S., July 20, 2020. REUTERS/Leah Millis

might a revenue test work? A firm would take out a revenue-tested loan. Revenue
during the covered period of the loan — say, the six months following the
loan’s origination — would be compared to revenue in the six-month period one
year before. Firms with larger revenue losses would have larger shares of their
loans forgiven.

a revenue test would act as a disincentive to earn revenue. If a revenue test
is in place, a firm that in 2020 earns, say, 90 percent of its 2019 revenue
receives less financial support from the government than an otherwise identical
firm that in 2020 earns 80 percent of its 2019 revenue.

dollar of additional revenue would be worth less than a dollar to the firm
because it would be accompanied by a smaller grant (i.e., a smaller portion of
its loan would be forgiven). In this way, the revenue test would operate as an
implicit revenue tax.

conservatives and elected officials believe that these sorts of implicit taxes
affect behavior in other settings. For example, it is commonly argued on the
right that the social safety net discourages paid employment among low-income
households because safety-net benefits phase out as household income rises. The
same underlying dynamics are at play in the revenue tests for small-business
assistance being considered by the Senate as part of Phase 4.

should avoid revenue tests entirely. But if Congress is going to do one, it
should be backward looking, not forward looking. For example, Congress
could condition the size of grants or forgivable loans to small businesses
based on their revenue loss for periods of time before a loan would be
originated under any Phase 4 program.

Congress could offer more generous financial assistance to firms that
experienced larger drops in revenue in the first six months of 2020 relative to
the first six months of 2019. (Alternatively, the comparison could be between
revenue during the period of February–July 2020 and the same months in 2019.) A
backward-looking revenue test like this would not directly disincentivize
earning revenue going forward.

would reward firms that performed less well in this crisis. But that is just
another way of saying it would focus aid on firms that need it most.

Congress would look to other ways to better target PPP and keep its costs down.
For example, Congress could restrict eligibility for the program to firms with
fewer than 300 employees. Current law allows firms with up to 500 employees to
participate. In addition, if banks were more confident that they would be held
harmless in the event of borrower misrepresentation, then small businesses that
don’t have existing relationships with PPP lenders would have greater access to
PPP funds. Congress could add language to the Phase 4 statute to make this happen.

Small businesses will face many obstacles in the coming months. Congress shouldn’t add forward-looking revenue tests to the list. If revenue tests are politically necessary, make them backward looking. Better yet, don’t have them at all.