Sole Proprietors’ Interest Expenditures in Long Term Decline

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Small business owners are paying a lot less to borrow money now than they did three decades ago.

That’s based on analysis of Internal Revenue Service (IRS) data. Per the IRS, the average sole proprietor paid four times as much on interest expense in 1983 as in 2011, when the numbers are measured in inflation-adjusted terms.

Although some of this decline in the amount of interest payments results from a reduction in the size of the average sole proprietorship, spending on interest has also declined as a fraction of sole proprietors’ sales. As the figure below shows, interest expense at sole proprietorships decreased from 2.1 percent of revenues in 1983 to 1.0 percent in 2011, the most recent year data are available.

However, most of this reduction occurred in the 1980s and 1990s. Since 2001, interest expense as a percentage of sales has remained roughly constant.

The decline in interest expense has a few different causes:

The first is the fall in interest rates. The Federal Reserve reports that the prime interest rate dropped from 10.8 percent in 1983 to 3.25 percent in 2014.

The second is the reduction in the fraction of small businesses borrowing. According to the National Federation of Independent Business’s monthly survey of its members, 38 percent of small businesses borrowed at least once a quarter back in 1986. In 2014, that fraction was down to 31 percent.

The third is the decline in average loan size. While data on the dollar value of commercial and industrial loans is not available before the late 1990s, Federal Reserve data reveal that the average commercial and industrial bank loan in 2014 was 43 percent smaller than the average loan in 1997.

One factor that doesn’t seem to be responsible is a shift of small businesses to greater reliance on equity financing. Sole proprietors’ interest expenditures have fallen, even though liabilities as a percentage of proprietors’ equity increased from 30.7 percent in 1980 to 68.8 percent in 2013, Federal Reserve data reveals.