Small Business, Big Regulatory Burden

By Scott Shane

President Obama recently acknowledged the burden placed on enterprise. But does he know how large that burden is?

A synonym for “legislator” illustrates the problem many small business owners have with the government today. That word is “lawmaker.” Making laws is what many small business owners see as so problematic with Washington.

Small business owners are increasingly saddled with regulatory compliance, a burden that hinders the productivity of their economic sector. And they are beginning to push back against the tide of rules coming from Washington.

To President Obama’s credit, he appears to be listening. In an opinion piece in the Wall Street Journal on Tuesday, President Obama wrote, “Sometimes, those rules have gotten out of balance, placing unreasonable burdens on business—burdens that have stifled innovation and have had a chilling effect on growth and jobs.”

President Obama wrote that regulations sometimes ‘have gotten out of balance, placing unreasonable burdens on business.’

Adhering to government rules is costly for businesses. Two Lafayette University economists, Nicole and Mark Crain, calculated that adhering to federal regulations alone cost $1.75 trillion in 2008, more than $15,000 per household. And business, as Crain and Crain explain, pays 55 percent of these costs.

The regulatory burden is particularly heavy on small business. Crain and Crain calculated that adhering to federal rules cost $10,585 per worker for businesses with 19 or fewer workers, but only 78 percent of that amount for businesses with 500-plus workers.

For some types of regulation, the gap between big and small firms in the compliance burden is even larger. Crain and Crain’s analysis shows that the per-employee cost of compliance with tax laws is $1,584 for businesses with 19 or fewer workers, but only $517 per worker for companies with 500-plus workers. For compliance with environmental regulations, the difference is a massive $4,101 for businesses with 19 or fewer workers and $883 per worker for companies with 500-plus workers.

Regulation is more of a burden for small companies than for large ones. Because much of the expense of adhering to governmental rules is the same regardless of business size, regulatory compliance has a high fixed cost and a low marginal cost. Big companies can spread the fixed cost across more revenue and employment than small companies. This, as any student of economics will tell you, is a classic example of economies of scale.

Not only is small business’s regulatory burden disproportionately large, it has also gotten heavier in recent years. The figure below shows what small businesses pay per employee to adhere to federal rules increased more than 21 percent in real terms between 2004 and 2008.

Small business owners have noticed this increased cost of regulation and increasingly see it as a problem. Back in 1986, the members of the National Federation of Independent Businesses reported that “unreasonable governmental regulations” was only the 22nd most important problem small business owners faced. In 2008, they said it was sixth.

What can we do about this increasingly heavy compliance burden on small business owners? Some observers believe that putting more heft behind the Regulatory Flexibility Act—a law that makes it mandatory for government agencies to examine the impact of new regulations on small businesses before they implement those rules—would alleviate the regulatory burden on small business. Advocates of this position claim that pushing government agencies to more carefully examine the costs of regulation to small companies would convince the federal bureaucracy to cut back on such regulations. The president seems to agree. In his opinion piece, he said, “Today I am directing federal agencies to do more to account for—and reduce—the burdens regulations may place on small businesses.”

Federal rules cost $10,585 per worker in businesses with 19 or fewer workers, but only 73 percent of that amount for businesses with 500-plus workers.

While this is a start, it is not enough. Simply knowing that regulation imposes weight on small business owners will do little to get the bureaucracy to cut such regulation. Policy makers in most government agencies already know that small business faces a heavy and increasing regulatory burden.

Moreover, much of the regulatory burden is coming not from the bureaucracy but directly from Congress in the form of laws like the healthcare and financial reform legislation. If we are to lift the burden of regulation from small business, we need Congress to stop over-regulating small companies. A first step toward this goal would be for those in Congress to pledge not to increase the regulatory burden on small business and to commit to cutting it back by a fixed amount—at a minimum, by the amount that burden has increased in recent years.

The outcome of the recent midterm election suggests that Congress might just do that. Many small business owners threw their support behind the Tea Party because it aims to change the term “lawmaker” into “law repealer.” Anti-regulation pressure that the Tea Party is exerting on Congress might reduce the regulatory burden on small business back to an acceptable level.

Scott Shane is the A. Malachi Mixon III Professor of Entrepreneurial Studies at Case Western Reserve University.