The federal regulatory monster inflicts massive costs on the U.S. economy. No sector feels this statist wrath more sharply than small business.
Perhaps burdened the most are small, enterprising firms looking to expand. Like the federal progressive income tax, many regulations punish success: a growing firm that adds employees faces an ever-increasing regulatory burden. Indeed, the incentives to stay small are considerable.
While placing hard numbers on the burdens government imposes on the economy and predicting future burdens are dicey endeavors, the following sobering estimates are worth noting. In a 1996 study, economist Thomas Hopkins projected that the total cost of federal regulations would be $700 billion for 1998, measured in 1995 dollars. That represents a real increase of 28 percent over the recent low of $549 billion a decade ago in 1988. Of course, regulatory costs fall hardest on smaller enterprises. Estimated per employee, costs for firms with fewer than 20 employees run 86 percent higher than those for businesses topping the 500-employee mark. Firms with 20 to 499 employers have costs 78 percent higher than larger companies.
However, as The Economist magazine noted in its July 27, 1996, issue, Hopkins’s projections were “conservative.” For example, they did not include federal regulatory enforcement spending, which, at the very least, approaches $20 billion annually. Also, according to the magazine, Hopkins’s figures “include only the burden of complying with rules for which cost studies have been done. Some costs, such as the loss of productivity caused when new regulation forces firms to adjust, are left out altogether.”
Economist Richard Vedder estimated that federal regulatory activity from 1963 through 1993 reduced productivity growth by one percentage point annually, meaning that GDP in 1993 would have been $7.614 trillion instead of $6.343 trillion. That’s a $1.27 trillion loss in economic output due to increased federal regulatory activity—in addition to compliance costs and federal spending.
In 1992, analysts Nancy Boyd and William Laffer III estimated that total federal and state net regulatory costs (after accounting for the so-called benefits of regulation) registered upwards of $1.7 trillion annually. Laffer further estimated that lost GDP growth due to excessive regulation over the previous two decades led to an absence of 3.6 million to 9.6 million jobs that would have been created.
Make no mistake, small to mid-sized businesses are the primary engine of job creation in the economy, accounting for anywhere from two-thirds to more than 100 percent of net jobs created in any particular year. According to an analysis performed for the Small Business Administration, firms with fewer than 500 employees in 1992 created almost 12 million new jobs by the close of 1996. By contrast, firms with more than 500 employees in 1992 wound up losing 645,000 jobs by 1996. Therefore, since the burdens of regulation fall heaviest on small businesses, the impact of regulatory costs on employment is bound to be severe.
To reduce the regulatory burden, over the years Congress has exempted many businesses from certain regulations based on the number of employees. Regulations take effect at thresholds ranging from 10 to 100 workers.
Unfortunately, this is another example of good intentions gone awry. Quite simply, as a firm grows and adds employees, it is subject to new regulations and therefore higher costs. For the small business content to stay quite small, exemptions may work in their favor (though they will still be hurt, as we all are, by regulation’s overall damage done to the economy). However, for businesses seeking to grow, formidable additional costs are imposed as new regulations kick in. Any business considering expansion must ask if the increased regulatory costs of hiring more people outweigh the added profit made possible by the new employees? In the language of economics, does the marginal cost of labor now exceed the marginal revenue product? If so, new employees will not be added.
For many businesses, it makes sense to apply the brakes and stop growing. Indeed, for some, it actually may pay to get rid of some employees to avoid being hit by new regulations. A study by Congress’s Joint Economic Committee estimated that under the Family and Medical Leave Act, which takes effect at 50 employees, a firm with 60 workers could increase profits by cutting back to 49.
There are many anecdotes about companies cutting off expansion after reaching the threshold at which additional regulations take effect. Senator Robert Bennett reported an encounter with a businesswoman who said her company was at “49 and holding.” She had no plans to hire more workers, because of the new regulatory burden that would follow. “If we didn’t have the regulatory overhang that comes with 50 employees,” she told the senator, “I could hire an additional five, seven, or ten people. I could do it tomorrow. But I’m not going to. We are 49 and holding. I know a lot of businesses in the same circumstance.”
The Wall Street Journal reported in 1993 that a Pittsburgh company that processes flat-rolled steel coils increased its work force to 49 and then stopped to avoid the clutches of the Family and Medical Leave Act. A letter to the Washington Times in 1992 told of a Virginia instrument company that kept employment below 50 to avoid having annually to submit paperwork related to nondiscrimination in hiring; one company that exceeded 50 had submitted a file weighing more than eight pounds.
Is There a Solution?
As an answer to this threshold problem, regulation enthusiasts would extend the rules to small business. But spreading the economic damage makes no sense if one is concerned about the state of small business and the society’s economic well-being.
Another option is to lift the bar even higher—say, to 250 or 500 employees. That would exempt more businesses, but growth-oriented companies would still find themselves stifled.
The only real answer is deregulation. The imposition of new regulatory burdens on all businesses should be stopped, and existing onerous regulations should be repealed. Most are simply unwarranted meddling in the marketplace. The government must get out of the way.
- Thomas D. Hopkins, “Regulatory Costs in Profile,” Center for the Study of American Business, Washington University, St. Louis, August 1996.
- Richard K. Vedder, “Federal Regulation’s Impact on the Productivity Slowdown: A Trillion-Dollar Drag,” Center for the Study of American Business, Washington University, St. Louis, July 1996.
- William G. Laffer III, “How Regulation Is Destroying American Jobs,” Backgrounder #926, Heritage Foundation, Washington, D.C., February 16, 1993.
- Joint Economic Committee, “Derailing the Small Business Job Express,” United States Congress, November 7, 1992.
- Quoted in “Isn’t Anybody Back There Listening?,” Inc., October 1993.