10/27/95

 

 THE CHANGING BURDEN OF REGULATION, PAPERWORK, 

 AND TAX COMPLIANCE ON SMALL BUSINESS

 A REPORT TO CONGRESS

 Office of the Chief Counsel for Advocacy

 U.S. Small Business Administration

 Washington, DC

 

 October 1995

________________________________________________________________

 Table of Contents

 

 Page

Introduction 

I. Changing the Regulatory Process for Small Firms

II. Regulations' Disproportionate Impact on Small Firms 

III. Tax-Related Paperwork Burdens 

IV. Trends in the Burdens of Regulation on the Private Sector

V. Total Benefits of Regulation 

VI. Allocation of the Burdens of Regulation by Industry and Firm

 Size 

VII. The Future of Regulation

_________________________________________________________________

 THE CHANGING BURDEN OF REGULATION, PAPERWORK,

 AND TAX COMPLIANCE ON SMALL BUSINESS

Introduction

 When small business owners get together at events like the White House

Conference on Small Business, the problem of complying with regulations and

dealing with regulators is always a major topic of conversation. The

paperwork burden of the Internal Revenue Service (IRS) is the primary

concern because preparing a regular payroll is a constant reminder of the

numerous rules and regulations dealing with tax withholding and reporting.

 But businesses' concerns are not limited solely to paperwork issues.

Small business owners often fear that they will inadvertently fail to

comply with some obscure rule, and that a government inspector will show

up, close down the business, and drive them into bankruptcy. Many believe,

with some justification, that the government is more interested in

obtaining penalties than in promoting compliance with the law. The recent

efforts to make the government more customer-friendly, while important and

dramatic, have not yet changed this longstanding perception.

 When leading thinkers on small business issues assembled late in 1994

under the aegis of the White House Conference to discuss barriers to entry

for small businesses, all 15 focus groups cited the burdens of regulations,

paperwork, and taxpayer compliance.

 Because of the widespread interest in this issue, the Congress

requested that the chief counsel for advocacy complete a "study of the

impact of all Federal regulatory, paperwork and tax requirements upon small

business..." This Office of Advocacy report is based on some earlier

landmark research, current research initiated by the office and a review of

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the current regulatory developments. 

 The importance of maintaining a viable, dynamic, and progressive role

for small businesses in the American economy is beyond dispute. The

nation's traditional values of individual initiative, social mobility, and

political freedom are dependent on the free enterprise system which, in

turn, depends upon the competition provided by a large and healthy

community of small firms. Policies that encourage a growing small business

sector will also ensure, as research has shown, increasing job

opportunities, a continuous flow of innovations, more vigorous competition,

and an ever-increasing standard of living.

 This report addresses the burden of regulation, paperwork, and tax

requirements, how that burden affects the cost structure of small firms

relative to large firms, and, ultimately, how it may affect their

profitability. It is the regulatory impact on the cost structure of a firm

that makes regulation a major concern for small business owners. 

 Three questions need to be addressed:

 1) Does the burden of regulation fall more heavily on small

 firms?

 2) If so, is it good public policy to regulate in such a way

 as to give large firms a competitive cost advantage in

 the marketplace?

 3) If the answer is no, how can the regulatory process be

 changed to help achieve a level playing field?

 Before addressing these questions, it is important to note that this

report does not attempt to measure the benefits of regulation, nor to

allocate the benefits by firm size. First and foremost, comprehensive

research estimating benefits is not available. Second, it is nearly

impossible to allocate benefits among the affected persons and businesses.

 Benefits are distributed throughout society as a whole. Clean water,

for example, benefits the food processing, dairy, and outdoor recreation

industries, among others. But the costs are concentrated on those being

regulated--in this example, on the firms that must find alternatives to

discharging pollutants into the waterways. Such firms may or may not derive

direct benefits from clean water regulations to offset their compliance

costs. Thus, it is extremely difficult either to estimate total benefits or

to allocate those benefits among the affected sectors of society.

 Last, irrespective of the benefits of a given regulation, the

knowledge of the existence of a disproportionate cost impact on smaller

firms is important to policymakers. The size, nature, and trends of the

disproportionate effect should dictate different policy responses by

decisionmakers (e.g. strengthening the Regulatory Flexibility Act or

providing more compliance assistance to small firms). 

 This report, the first of its kind, focuses on measuring total

regulatory costs, identifying how they are allocated among small and large

firms, and discerning whether the regulatory environment is unnecessarily

impeding the birth and growth of small businesses. 

 Finally, the report discusses initiatives taken by the Clinton

Administration and the Congress to reduce the cost of regulation. Executive

Order 12866 establishes a review process for all significant regulations to

ensure that rules are cost-effective and minimize small business burdens.

Certain cabinet agencies are revising their enforcement policies to

emphasize compliance, rather than the imposition and recovery of penalties.

The Paperwork Reduction Act (PRA) and the Regulatory Flexibility Act (RFA)

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require agencies to review the impact of their regulations on small

businesses and consider less costly alternatives for accomplishing public

policy objectives.

 The report does not, however, factor in the cost savings generated by

these initiatives, largely because the data are not available and because

the savings are diffused throughout the economy. Also, some of the

initiatives are too new to have had any concrete impact on small

businesses. As a consequence, the perception persists among small firms

that the regulatory burden is ever-increasing.

 The perception is not totally inaccurate: the aggregate regulatory

burden is still increasing. However, the relative burden, compared with the

size of the economy, has been reasonably constant in recent years. In other

words, the amount of regulation is growing at the same rate as the overall

economy. The significant issue is how these costs are divided among firms

of different sizes that compete with one another.

 The Office of Advocacy funded research to address this issue and

outlined the research parameters to be followed by the contractor. This

research and other available data lead to the conclusion that the average

annual cost of regulation, paperwork, and tax compliance for firms with

fewer than 500 employees is about $5,000 per employee, compared with about

$3,400 per employee for firms with more than 500 employees. While the total

burden on a firm increases with firm size, the burden per employee or per

dollar of sales decreases with firm size. 

 Thus, the answer to the first question, whether the regulatory burden

falls more heavily on small firms, is yes: the regulatory cost per employee

to small firms is approximately 50 percent more than the cost to large

firms. Small businesses employ 53 percent of the work force, but shoulder

63 percent of the total business regulatory costs. 

 This inequitable cost allocation gives large firms a competitive

advantage, a result at odds with the national interest in maintaining a

viable, dynamic, and progressive role for small businesses in the American

economy. It appears then that the answer to the second question is that an

inequitable allocation of regulatory costs is not good public policy.

 As for the third question -- how the regulatory process can be

improved -- the finding further suggests that, despite more than 13 years'

experience with the Regulatory Flexibility Act, public policy makers need

additional direction to reconcile their regulatory decisions with the

national goal of preserving competition through the growth of small

business. The need for regulatory reform through initiatives such as

amending the RFA is great.

 In support of these findings, the Office of Advocacy submits the

following report to Congress, which is organized as follows: Section I

reviews recent revisions in the regulatory process affecting small firms.

Section II proffers the theory and empirical evidence of disparate burdens

on different sizes of business caused by regulation. Section III reviews

tax-related paperwork burdens. Section IV addresses the total cost of

regulation. Section V reviews the literature on benefits. Section VI

allocates the cost of regulation by industry and firm size. The final

section develops the Office of Advocacy's conclusions and discusses

the future of regulation. 

_________________________________________________________________

I. CHANGING THE REGULATORY PROCESS FOR SMALL FIRMS

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 President Clinton is committed to reinventing the federal regulatory

process and reducing the burden of government on small firms. He initiated

the Small Business Forum on Regulatory Reform, which brought together small

businesses and federal agencies to formulate new solutions to help make

regulations more cost-effective. The president directed federal departments

to cut in half the frequency with which firms must file most reports (for

example, quarterly reports will be due only semi-annually). Agencies are

redoubling their efforts to focus on results, not red tape.

Executive Order 12866

 On September 30, 1993, President Clinton initiated the

administration's efforts to ease the regulatory burden on small firms by

issuing Executive Order 12866, "Regulatory Planning and Review." This order

requires federal agencies to analyze carefully their major regulatory

undertakings and to take action to ensure that these regulations achieve

the desired results with a minimum societal burden. A major objective of

this executive order is to reduce the disproportionate share of the federal

regulatory burden that falls on small businesses. Under the executive

order:

 (1) each agency must choose the approach that maximizes net

 benefits, unless the statute requires another regulatory

 approach;

 (2) each agency should assess the costs and benefits of

 regulatory alternatives, including the alternative of no

 regulation; and

 (3) each agency must tailor its regulations to impose the

 least burden on society, including businesses of

 different sizes, consistent with achieving the

 regulatory objectives.

 Each "economically significant regulatory action" is to be accompanied

by a formal regulatory analysis that includes an assessment of the

potential costs and benefits of each regulatory alternative. Under the

current Regulatory Flexibility Act, an analysis of regulatory alternatives

minimizing the impacts on small businesses is required if there is likely

to be a "significant economic impact on a substantial number of small

entities." Implementation of the principles of the RFA has saved

hundreds of millions of dollars annually for small businesses in

Environmental Protection Agency (EPA) rulemakings alone.

 Executive Order 12866 requires that significant regulations and the

accompanying analyses be reviewed by the Office of Management and Budget

(OMB) for compliance. The OMB has agreed to work with the Office of

Advocacy regarding agency noncompliance with the Regulatory Flexibility

Act.

 The vice president is the president's principal regulatory advisor. A

senior-level interagency regulatory working group has been established to

promote the development of regulations consistent with the president's

priorities and to minimize regulatory inconsistency and duplication among

the various agencies. Each agency also develops an annual regulatory plan

that describes the agency's most significant regulatory actions for the

next fiscal year.

Reinventing Government

 The National Performance Review (NPR), carried out by the Office of

the Vice President, required a comprehensive review of all governmental

functions in the first year of the Clinton Administration, and included

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substantial scrutiny of the regulatory process. The following are among the

regulatory recommendations: (1) encourage more innovative approaches to

regulations, (2) encourage consensus-based rulemaking, (3) enhance public

participation in rulemaking, and (4) streamline agency rulemaking

procedures. One important NPR recommendation advises federal agencies to

include an inquiry about business size in all business surveys to ensure

that policymakers making decisions affecting small businesses have adequate

data. The regulatory component of the NPR reinforces the principles of

Executive Order 12866.

 On February 25, 1995, President Clinton initiated Phase II of the

National Performance Review by directing all federal agencies to conduct a

page-by-page review of all regulations and to eliminate or modify those

regulations in need of reform. The president also directed the agencies to

identify more opportunities for consensual rulemakings and to improve the

management of federal regulatory programs.

 The overhaul of the small business penalty policy, announced a month

later, is an especially important part of regulatory reform. Agencies were

ordered to waive up to 100 percent of any punitive penalty for any small

firm that attempts in good faith to comply with regulations and corrects a

violation within a reasonable time. If there is a penalty of any kind, the

small business may be permitted to use the money to fix the problem, rather

than paying a fine to the government. This policy marks a substantial

change for the enforcement programs, which have traditionally been

penalty-oriented, rather than compliance-oriented.

 At the White House Conference on Small Business, President Clinton

announced the preliminary results of the administration's recent regulatory

review of existing regulations. More than 16,000 pages are being eliminated

from the Code of Federal Regulations, including 50 percent of the Small

Business Administration rules and 40 percent of the Department of Education

rules. Another 31,000 pages are being modified. A 25-percent reduction in

the Environmental Protection Agency's paperwork burden was also targeted

for action. 

 

Congressional Regulatory Reform Efforts

 The legislative centerpiece for small business regulatory reform has

been, and remains, the Regulatory Flexibility Act of 1980. This study

confirms the RFA's original premise, namely that small firms suffer a

disproportionate impact from federal regulations. It is still true today.

Pending legislation to amend the RFA is of key interest to small

businesses. For many years, small business trade groups have sought to

strengthen the RFA by permitting judicial review of agency compliance with

the act. H.R. 9, the Job Creation and Wage Enhancement Act of 1995,

passed by the House of Representatives, would permit judicial review for up

to one year after enactment of the final rule. 

 The Paperwork Reduction Act was also reauthorized in 1995. The PRA

establishes a process to control the proliferation of paperwork and

recordkeeping requirements and was designed, in part, to help small

businesses. Originally passed in 1980, the law gives the Office of

Management and Budget the authority to approve all federal paperwork and

recordkeeping requirements, even those of the independent agencies not

subject to Executive Order 12866. 

 The PRA reauthorization legislation strengthens the 1980 act and

requires federal agencies to reduce their paperwork requirements by 10

percent per year in 1996 and 1997, and by 5 percent each year thereafter.

The new law also extends PRA coverage to include federal agency disclosure

requirements and information required to be disclosed to third parties (for

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example, manufacturers of hazardous chemicals must provide material safety

data sheets to chemical purchasers). This significant change sought by

small businesses overturns a 1990 Supreme Court decision that had

negatively affected millions of small businesses. This summer, OMB issued

its final regulations implementing the reauthorized Paperwork Reduction

Act. 

 Congress also has shown great interest in other legislation promoting

regulatory reform and paperwork reduction. H.R. 9, for example, contains

various elements of regulatory reform addressing risk assessment,

cost/benefit analysis, and regulatory flexibility for small businesses. The

legislation would also require the use of outside peer review groups to

help ensure that the analyses are objective and unbiased. The merit of some

of these reform provisions is subject to considerable debate.

 Clearly, this administration and Congress plan to reduce not only the

aggregate burden on small firms, but also regulation of all businesses.

However, several obstacles to curbing the rising cost of regulations

remain. First, there is a backlog of federal regulatory requirements that

are required to be issued now and into the future. For example, the 1990

Amendments to the Clean Air Act require EPA to promulgate dozens of rules,

well beyond the year 2000, causing clean air costs to continue to rise at

least through the year 2005. Second, new legislation frequently requires

the issuance of more regulations. Third, even the demand for the

clarification of old regulatory requirements generates new rules to be read

and understood.

The 1995 White House Conference on Small Business

 In 1994 and 1995, more than 20,000 small business leaders participated

in more than 50 state and regional meetings to formulate recommendations

for federal action on small business issues. This activity culminated in

the 1995 White House Conference on Small Business. The delegates sent to

the president and the Congress a list of 60 key recommendations addressing

many issue areas, including regulation, paperwork, and taxpayer

requirements. These recommendations include cost/benefit analyses, fairer

enforcement policies, judicial review of the Regulatory Flexibility Act,

and paperwork reduction. 

_________________________________________________________________

II. REGULATIONS' DISPROPORTIONATE IMPACT ON SMALL FIRMS

The Theory 

 The theory of how the costs of regulation, paperwork and tax

compliance vary by firm size is relatively straightforward. A significant

body of knowledge must be gained by a firm to determine whether a

regulation applies to it, whether it is in compliance, or what action must

be taken to be in compliance. For example, a firm must first learn that a

form is required by rule, determine if the firm is required to submit that

form, and then determine how to complete the form correctly. These fixed

information-gathering costs are the same for all firms, whether large or

small. The large firm advantage is its ability to spread its fixed

regulatory costs among more units of output, dollars of sales, or

employees, resulting in lower costs per unit. The theory predicts that if

the regulatory costs are fixed, the relative burden will decline in

proportion to the quantity of goods or services produced (Figure 1). 

 However, not all regulatory costs are fixed. Costs that grow with an

increase in output or firm size, such as labor costs, are variable. With

most regulations, these variable costs will be constant per unit of sales

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or employment. 

 Every regulation has fixed costs and some regulations have additional

variable costs. 

Insert Figure 1: COST PER UNIT OF OUTPUT OR INPUT BY SIZE OF FIRM

A line graph show high cost for small firms, sharply curving downward as

size of firm increases.

 Thus, one would expect that the per-unit regulatory costs will decline

as firm size grows. How much these costs decline depends on the

relationship between fixed and variable costs. Adding the costs of

regulation, paperwork, and tax compliance onto the traditional cost

structure raises costs and lowers profits for smaller firms relative to

larger firms, suggesting that the startup of new small firms would be more

difficult. Thus, the innovative activity brought about by new small firms

would be slowed, with the potential deceleration of economic growth in the

industry and the economy.

 Compounding the problem, with every new regulation that increases

fixed costs, a number of existing small firms may be forced to leave the

industry because they cannot cover the additional costs of the regulations.

Competition within an industry will decrease, and the industry structure

will become more dominated by large firms.

 Since the relative burden on small firms is higher because of the

fixed-cost nature of regulation, Congress and a number of regulatory

agencies have, on occasion, exempted small firms through "tiering" of the

laws and rules.

 Tiering is designing regulations to account for relevant

 differences among those being regulated. Tiering may be

 desirable when a uniform rule would otherwise impose

 disproportionate impacts on regulated businesses. By

 tiering, an agency can alleviate disproportionate burdens,

 ensure that the regulatory solution fits the problem, and

 make more efficient use of its limited enforcement

 resources. This concept of designing flexible alternatives

 to uniform rules is the heart of the recently enacted

 Regulatory Flexibility Act (RFA) (P.L. 96-354). In that act,

 Congress instructed federal agencies to explore

 alternatives, such as tiering, to minimize the

 disproportionate impact of regulations on small businesses,

 associations and governmental units. 

 In many cases tiering is an effective way of increasing the

 cost-effectiveness of a regulation. EPA has tiered up to 50

 different regulations based either on firm size or the

 amount of pollutant released. A possible disadvantage is

 that tiered regulations may provide a disincentive for a

 firm to grow and, consequently, subject itself to a more

 stringent standard. Additionally, in certain cases, it may

 be difficult to set an appropriate tier.

 

 Consequently, empirical studies may or may not show a declining burden

by firm size as the theory suggests, depending on the amount of tiering

utilized in a particular regulation. Since the passage of the RFA,

Congress has frequently required the tiering of regulatory standards for

small firms.

The Evidence

 Several reports are available on the relative cost of regulations for

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large versus small businesses, almost all in response to research requests

issued by the Office of Economic Research in the Office of Advocacy and

performed under contract with the U.S. Small Business Administration over

the last 15 years. Some estimate the costs imposed on small businesses by

the rules; others attempt to measure the actual regulation and paperwork

costs borne by small businesses. 

 Small business regulatory burdens may be reduced in a number of ways,

both intentional and unintentional. They may be reduced intentionally by

tiering. The actual regulatory burdens are also reduced for small firms by

the extent to which they are not aware of the regulations or otherwise fail

to comply with the rules.

 At the direction of the Office of Advocacy, Thomas Hopkins and

Diversified Research prepared a study, A Survey of Regulatory Burdens. The

study found that about 40 percent of the 360 small businesses surveyed

indicated that small firms in their industries did not fully comply with

most regulations. The small businesses cited ignorance of the rules as the

most common cause of this lack of compliance. 

 In recent years, small firms appear to have been overwhelmed by the

growing and constantly changing mass of federal, state, and local

requirements. Thus, one might expect regulatory impact studies to differ in

result, depending on whether the inquiry is directed at the regulatory

burden imposed by the rules, or the regulatory burden actually borne by the

businesses (which may be less because of noncompliance). In fact, this

difference has long been noted in the literature.

 A 1980 study of actual compliance costs by Battelle found that very

small businesses with fewer than 50 employees bear a disproportionate cost

burden from regulations, compared with businesses with 50-500 employees. 

For every one of 21 different compliance costs surveyed in a study of 361

Washington State businesses, the costs were roughly 7 to 10 times higher

for the small firms. 

 Similarly, Jack Faucett Associates found in 1984 that a set of 14

federal regulations promulgated in the late 1970s and early 1980s had a

disproportionate impact on small firms. The cost per employee for small

firms was 2.83 times that for large firms. The mid-sized firm multiple was

1.35. This report relied solely on the federal government's cost estimates

for the proposed rules -- not for the final rules that were later

promulgated -- and therefore, the study only estimated expected costs

without measuring the actual costs incurred.

 An examination of the actual costs incurred by firms complying with

environmental and health and safety regulations between 1974 and 1981 by

David Evans shows the contrast among some of the empirical studies. In

actuality, the Evans study found that large firms spent more per employee

than small firms. Specifically, every one percent in establishment

employment increase corresponded to a 1.46-percent increase in pollution

abatement operating costs for the years 1974-1981. 

 A 1984 research paper that also addressed pollution costs actually

incurred reached conclusions that were contrary to Evans' findings that

large firms spend more per employee than small firms. Peter Pashigian found

that higher regulatory costs hurt small businesses more than large

businesses. This report concluded that industries with high

pollution-abatement costs became more capital-intensive, had larger

increases in mean plant size (i.e. the number of smaller plants declined

over time) and had larger decreases in the number of plants over the years

1972-1977. In addition, small firms' market share in high pollutionabatement-cost industries declined relative to their share of

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industries with lower costs. However, Brock and Evans questioned the

statistical validity of some of Pashigian's results. 

 In a more recent study, Thomas Dean found that environmental

regulations deterred the formation of small establishments, but had no

significant effect on large establishment formation or establishment size.

He postulated that the regulations produced disproportionate impacts on

small firms, not only because of the existence of scale economies, but also

because of the complexity of the regulations and other unspecified burdens.

 Another recent work focused attention on evidence that larger

businesses carried relatively larger burdens than did small businesses.

Brown, Hamilton & Medoff discussed the proliferation of small business

statutory exemptions and relaxed enforcement of regulations on smaller

firms. Indeed, a large number of statutes enacted throughout the 1980s and

1990s required tiering of regulations for small businesses, including the

Immigration Reform and Control Act of 1986, the Worker Adjustment and

Retraining Act of 1988, the Americans with Disabilities Act of 1990, the

Clean Air Act Amendments of 1990, and the Family and Medical Leave Act of

1993.

 In the 1995 Hopkins and Diversified report, the researchers found that

one-third of the firms faced only minor burdens, while two-thirds faced

moderate to substantial burdens. They found that total burdens increased

with firm size, but that burdens per unit of sales or per employee

decreased with firm size. 

 When firms were asked to describe the types of burdens they face, 94

percent said it was unclear what firms must do to be in compliance, 85

percent cited frequent changes in the regulations or their interpretation,

80 percent said it was difficult to obtain clear and specific answers to

questions about compliance, and 80 percent said the requirements to reach

full compliance were too costly.

 Of the firms that reported moderate to substantial burdens, the

smallest firms carried the heaviest burdens, the Hopkins study found. Using

this sample of reporting firms, the four smallest firm size classes (firms

with 1-4, 5-9, 10-19, and 20-49 employees) reported regulatory spending

percentages (costs to revenue) exceeding the average 14 percent of revenue,

excluding the relatively modest capital expenditures. Those firms with

20-49 employees spent, on average, 19 cents out of every revenue dollar on

regulatory costs. 

 Reported regulatory costs per employee were highest for the smallest

firms with 1-4 employees at $31,748; for the largest firms (500+

employees), total costs per employee were $16,241. However, these

normalized cost burdens are based on a sample of 181 businesses and include

only firms that reported more than a minor regulatory burden. This Advocacy

study, using national data drawn from other academic research, reports

lower per-employee costs.

_________________________________________________________________

III. TAX-RELATED PAPERWORK BURDENS

 The 1995 Hopkins and Diversified Research study confirms that tax

compliance and payroll recordkeeping are the two largest components of

regulatory burden today. Small businesses bear a greater relative burden of

tax compliance costs based on their revenue or senior management time. In

fact, tax compliance or payroll recordkeeping elicited widespread concerns

about burden, although some surveyed firms did mention other regulatory

costs that were burdensome. Firms with fewer than 10 employees (excluding

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firms reporting only minor burdens) reported that their tax and payroll

costs represented about 80 percent of their total regulatory burden. 

 When firms were asked how burdens might be reduced, 95 percent

recommended simplifying reporting and recordkeeping, 73 percent suggested

additional small business exemptions, and 68 percent asked for more

flexible enforcement.

 In the only study available in the United States on the impact of

tax-related paperwork on all firms by firm size, the Tax Foundation reports

that the smallest firms spend 0.5 percent of their sales on tax compliance

activity; the largest firms spend less than 0.1 percent of their sales on

tax paperwork (Table 1). The more recent 1995 Hopkins and Diversified study

shows that the smallest firms (those with fewer than 50 employees) spend

closer to 5 percent of revenue on tax compliance costs.

TABLE 1: Estimated Cost of Corporate Income Tax Compliance by Amount of

Company's Annual Sales

_________________________________________________________________

Annual Sales Compliance Cost-to-Sales Estimated

 Ratio Compliance Cost

(Thousands of $) (%) ($) 

_________________________________________________________________

 1,000 0.50 5,025

 25,000 0.50 126,000

 50,000 0.50 251,000

 100,000 0.47 470,000

 250,000 0.13 325,000

 500,000 0.13 650,000

 750,000 0.12 900,000

 1,250,000 0.07 875,000

 2,000,000 0.08 1,600,000

 3,000,000 0.07 2,100,000

 5,000,000 0.07 3,500,000

 7,500,000 0.05 3,750,000

10,000,000 0.05 5,000,000

Source: Arthur P. Hall, The High Cost of Tax Compliance for U.S. Business,

Special Report No. 25, Tax Foundation, November 1993.

_________________________________________________________________

 Recent administration actions have been undertaken that could

significantly reduce the taxpayer compliance burdens, including a proposed

increase from $10,000 to $25,000 in 1993 (subsequently reduced by Congress

to $17,500) in the amount of capital investment that businesses can

expense; simplified calculations for computing the individual alternative

minimum tax, simplified and unified determination of depreciation

deductions (allowing taxpayers to group certain assets in one or more

"general asset" accounts), an increased threshold for recordkeeping on

meals and entertainment expenses from $25 to $75, and rules that would

allow an unincorporated entity to elect to be treated as a partnership by

simply checking a box on its tax return (replacing complicated business

form criteria).

 The administration has moved forward on the Simplified Tax and Wage

Reporting System (STAWRS) that will ultimately enable an employer to file

a single return providing payroll and tax information electronically (or,

for a small business, on one sheet of paper that can be copied). This

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system would eliminate the need to file multiple reports with state and

federal agencies that require the same data. Finally, the administration

has proposed reforms to ease rules for participation in pension plans, and

reduce the frequency and quantity of information reports. These measures

should prove very beneficial to small businesses.

IV. TRENDS IN THE BURDENS OF REGULATION ON THE PRIVATE SECTOR

 In his new study for the Office of Advocacy, Thomas Hopkins updates

his earlier estimate of the total cost burden of regulation on the economy,

and then projects how these regulatory burdens are distributed to major

sectors of the economy and by firm size. His initial work, "The Cost of

Federal Regulations," was published in 1992. A second, unpublished paper

written in 1992, "Cost of Regulation: Filling the Gaps," updates the first

paper and provides more details on where the regulatory burdens come from

and where they fall (Table 2). 

TABLE 2: Distribution of Compliance Costs in 1991 (Percent)

_________________________________________________________________

 Percent

_________________________________________________________________

Environmental

 Air and Radiation 33.3

 Water 48.0

 Land 14.6

 All Others 4.1

Other Social Regulation

 Worker Health and Safety 33.6

 Auto Safety 29.5

 Nuclear Safety 24.7

 Other Consumer Protection 8.7

 Job Security 3.5

Economic Regulation

 Transportation 30.7

 International Trade 27.3

 Communication 22.3

 Agricultural/Natural Resources 11.6

 Financial 6.9

 Other Economic 1.2

Process Regulation 

 Paperwork 74.4

 State - Local Mandates 3.7

 Health 21.9

Source: Thomas D. Hopkins, Cost of Regulation: Filling the Gaps, August

1972.

_________________________________________________________________

Paperwork Costs

 The OMB's report on paperwork dated October 1993 reported 6.64 billion

hours of federal paperwork for fiscal year 1992, including 5.60 billion

hours from IRS taxpayer compliance. This represents a 0.7-percent decrease

from the previous year's level. OMB projected a 2-percent decrease for

fiscal year 1993, followed by a 0.5-percent increase for fiscal year 1994.

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Hopkins uses the OMB paperwork hourly estimates, and assumes a $26 per hour

labor rate to calculate the cost for the paperwork portion of "process

regulations."

Total Regulatory Costs

 Hopkins adds the cost of process regulations to environmental and

other social and economic regulatory costs to derive an estimate of total

regulatory costs of $668 billion (in 1995 dollars) in 1995, increasing to

$721 billion in 2000. (See Table 2 for the components of each of these

terms and Table 3 and Figure 2 for the costs.) Total costs fell from 1977

to 1988 and then increased from 1988 to 2000.

TABLE 3: Annualized Regulatory Costs in Billions of 1995 Dollars

 A: Environmental Regulation

 B: Other Social Regulation

 C: Economic Regulation Efficiency Costs

 D: Economic Regulation Transfer Costs

 E: Process Regulation

 F: Total Regulatory Costs

________________________________________________________________

Year A B C D E F

________________________________________________________________

1977 47 32 149 288 138 654

1978 52 35 142 273 139 640

1979 56 37 134 256 139 623

1980 60 39 125 239 143 605

1981 63 37 118 225 147 590

1982 65 35 113 213 144 570

1983 71 32 108 204 161 576

1984 76 31 103 194 163 567

1985 81 31 99 186 165 561

1986 87 31 95 177 165 555

1987 93 32 90 168 174 557

1988 98 34 86 158 173 548

1989 105 36 85 156 180 561

1990 112 39 83 153 206 593

1991 129 40 82 151 219 621

1992 137 47 82 150 226 642

1993 149 51 81 149 212 642

1994 152 53 80 148 215 649

1995 168 55 80 147 218 668

1996 174 58 79 145 221 677

1997 180 60 79 144 225 688

1998 188 62 78 143 229 700

1999 193 65 77 142 232 709

2000 199 68 77 141 236 721

Projected costs do not reflect savings from regulatory reform since 1993.

Source: Thomas D. Hopkins, Profiles of Regulatory Costs, SBA Contract

SBAHQ-95-M-0298 (Draft Final Report, 1995) Table A.

_________________________________________________________________

FIGURE 2: A pictorial graph reflecting data of Table 3

_________________________________________________________________

 Although Hopkins projects costs well into the future (to the year

2000), the Office of Advocacy believes these figures are highly

12 of 21 08/26/15 8:46 AM
speculative. Hopkins' future projections are likely an overestimate because

he does not estimate the cost reductions that will accrue from the

administrative and congressional initiatives to reinvent government and

reduce government regulation. Furthermore, it is extremely difficult to

estimate the future costs, for example, of environmental and tax

regulations that have yet to be written. Therefore, these

future projections are only suggestive of possible trends.

 The business community has total regulatory costs of some $400

billion, up from the $330 billion range in 1988. When the business share of

regulatory costs is distributed across sectors, it appears that

manufacturing firms carry about one-third of all business regulatory costs

in 1995. The rest of the costs are borne in roughly equal shares by trade,

services and all other industries. In constant dollars, the manufacturing

regulatory burden has climbed sharply since 1982, while the other sectors

have experienced little change. (See Figure 6 for the distribution of costs

by business sector.)

 The economic regulatory burden declined in the late 1970s with the

deregulation of transportation, natural gas and oil, and communications.

The burden of economic regulations has remained basically constant since

1988 and was expected to remain constant

into the 21st century.

 Process regulation in 1992 accounted for some 40 percent of total

business regulatory costs, while environmental regulation was the source of

about a quarter of total business regulatory costs. The burdens that are

increasing are environmental regulation and process (primarily paperwork)

regulation (Figure 3).

FIGURE 3: Regulatory Costs by Cost Category 1977-1993 (Billions of 1995

Dollars: A line graph showing rising and falling trends of the data in

Profiles of Regulatory Costs.

 When total costs are expressed relative to gross domestic product

(GDP), a decline also occurred from 1977 to 1988 (Figure 4). While

regulatory burdens have been increasing in absolute terms for the past

decade, since 1992, the increases have only matched the increases in GDP.

In other words, regulatory burdens have remained at approximately 9 percent

of GDP. Hopkins expects this relationship to continue through the year

2000.

FIGURE 4: Regulatory Costs as Percent of Gross Domestic Product, 1977-2000:

A line graph showing regulatory cost figures computed using EPA estimates

for the environmental regulatory cost component.

_________________________________________________________________

V. TOTAL BENEFITS OF REGULATION

 Ideally, the true measure of the burden of regulation is determined

by the difference between the total costs and the total benefits.

Unfortunately, although the benefits of regulations are important, no

reliable estimates of total benefits exist. According to a carefully

documented report by the Harvard Center for Risk Analysis, federal

regulations have had significant beneficial effects:

 For example, over the past 30 years the United States has

 made substantial progress in cleaning up air, water and

 land, in part due to the strong regulatory presence of the

 federal government. The automobile manufacturing industry is

 now producing cars that emit 75-95 percent fewer 

 pollutants from tailpipes than they did in 1968 -- a rate of

13 of 21 08/26/15 8:46 AM
 progress that would not have been achieved without strong

 federal regulation. Prevention of lead pollution has been a

 notable success story, as the national rate of lead

 emissions from all man-made sources has declined 96

 percent since 1970, and the concentrations of lead in the

 blood of children has fallen substantially, particularly

 since the lead content of gasoline was reduced and then

 eliminated. Product manufacturers have also responded to

 regulatory and liability pressure by paying more attention

 to safety in both design and manufacturing. Many new 

 cost-effective safety features have been added to products

 (e.g., airbags in automobiles) as a result of the continued

 prodding and regulatory presence of the federal

 government. . . . In short, many risk-reduction policies

 have been shown to have benefits greater than costs, even

 though benefits are sometimes difficult to estimate. 

 Hopkins' 1993 paper also includes some information about benefits:

 The net benefits of environmental regulation may be positive

 or negative. By 1990, the benefits of air pollution

 regulations probably were exceeding the compliance costs,

 perhaps by as much as $10 billion. For water pollution

 regulations, on the other hand, the results were just the

 opposite. The best information available suggests that costs

 exceeded benefits by roughly $20 billion per year in the

 water pollution area. For other environmental areas, we

 lack comparable data. The general trend appears to be the

 adoption of regulations whose benefits do not exceed their

 costs. The 1990 Clean Air Act Amendments very likely will

 impose additional compliance costs of $30 billion annually

 while generating far smaller additional benefits. This trend

 is driven in part by the fact that many of the low cost

 options for lessening risks already have been adopted.

 The burdens of regulation, like taxes, fall specifically on the

persons or businesses that pay, whereas the benefits tend to be more

generally distributed. Therefore, the complaints of the regulated will be

more focused than the appreciation of those benefiting from the regulation.

Thus, while it is common to focus on the more obvious cost of regulation,

the more elusively determined net benefit provides the public policy

foundation for a given rule. 

_________________________________________________________________

VI. ALLOCATION OF THE BURDEN OF REGULATIONS BY INDUSTRY AND FIRM SIZE

Hopkins' Estimates 

 Regulatory burden estimates for small firms have been made for a

specific regulation or sets of regulations in previous studies by asking

business owners to estimate their costs. To date, there has been no attempt

to allocate total regulatory costs across business sectors and firm sizes. 

 Based on his previous work, Thomas Hopkins of the Rochester Institute

of Technology was selected to fill this critical data gap. In his earlier

study for the Office of Advocacy, Hopkins surveyed 360 firms, most of them

small (with fewer than 500 employees), in 15 different industries. Based on

the survey, he developed estimates by firm size of the cost of regulation,

along with costs per employee and per dollar of sales. 

 The Office of Advocacy requested that Hopkins attempt this first

approximation of total burdens by firm size, using the data from his

14 of 21 08/26/15 8:46 AM
previous studies and elsewhere. Several steps were required. 

 Initially, Hopkins separated the regulatory burdens that fall on

consumers or state and local governments from the burdens that fall on

business. The business costs were divided into industrial sectors, and

further subdivided by firm size. The following allocation rules that were

developed in earlier research studies or from anecdotal evidence were used

to separate business from nonbusiness regulatory costs:

 Percent of Regulatory Costs Borne By

 Business Government & Consumers

 

Environmental regulation 65 35 

Other social regulation 100

Economic regulation (transfer 

 and efficiency costs) 50 50 

Process regulation 

 (primarily paperwork) 

 Mandates 100 

 Health care 50 50 

 Tax paperwork 67 33 

 Other paperwork 100

 The allocation of -- and trends in -- these costs are shown in Figure

5. The business costs were then allocated to the various industrial sectors

using research and anecdotal evidence:

FIGURE 5 is a pictorial graph showing Business Share of Regulatory Costs,

1977-2000 in Billions of 1995 dollars, contrasting the business share with

the non-business share.

 Percent of Regulatory Costs Borne By

 Mfg. Trade Services Other 

Environmental regulation 70 10 10 10

Other social regulations 40 20 20 20

 For all other regulation (economic and process), costs are allocated

across the four sectors in proportion to the employment share.

 These allocations and the resulting trends through time are shown in

Figure 6.

 The scheme for allocating costs by firm size was derived using data in

the Hopkins study, A Survey of Regulatory Burdens. Among the enterprises

facing at least moderate regulatory burdens per employee, firms employing

fewer than 20 employees reported costs that exceeded the average cost per

employee for all firms by 30 percent. Hopkins divided the total regulatory

cost per sector by the number of employees to derive the average cost per

employee. The average cost per employee is multiplied by 130 percent to

represent the cost for the smallest firms, and the remaining cost is

allocated to the 20-499 employee size firms and large firms (500+

employees). His results are shown in Table 4. 

_________________________________________________________________

TABLE 4: Business Regulatory Burdens by Sector. 1992. The Hopkins Case

(1995 Dollars)

 A= Total Cost (billions)

15 of 21 08/26/15 8:46 AM
 B= Cost per Firm

 C= Average Cost Per Employee

 D= Cost per Employee by Firm Size

 Da= <20

 Db= 20-499

 Dc= 500+

 E= Cost as a Percent of Receipts

 Manufacturing

Type Regulation A B C Da Db Dc E

Environment 62 188,909 3,413 4,437 5,218 2,389 1.8

Other Social 19 57,891 1,046 1,360 1,599 732 0.6

Economic (Effic-

 iency Costs) 7 21,328 385 501 589 270 0.2

Economic (Trans-

 fer Costs) 13 39,610 716 930 1,094 501 0.4

Process 25 76,173 1,376 1,789 2,104 963 0.7

Total Regulatory 

 Costs 126 389,911 6,936 9,016 10,605 4,855 3.7

 Trade 

Type Regulation A B C Da Db Dc E

Environment 9 6,125 349 454 411 244 0.2

Other Social 9 6,125 349 454 511 244 0.2

Economic (Effic-

 iency Costs) 10 6,806 388 504 456 272 0.2

Economic (Trans-

 fer Costs) 18 12,250 698 908 821 489 0.3

Process 35 23,819 1,358 1,765 1,596 950 0.6

Total Regulatory 

 Costs 82 55,805 3,181 4,135 3,740 2,227 1.4

 Services 

Type Regulation A B C Da Db Dc E

Environment 9 4,584 293 382 341 205 0.5

Other Social 9 4,584 293 382 341 205 0.5

Economic (Effic-

 iency Costs) 12 6,111 391 509 454 274 0.6

Economic (Trans-

 fer Costs) 22 11,204 717 933 833 502 1.1

Process 42 21,390 1,370 1,780 1,590 959 2.1

Total Regulatory 

 Costs 94 47,872 3,065 3,985 3,558 2,146 4.8

 Other 

Type Regulation A B C Da Db Dc E

Environment 9 6,563 494 642 608 346 0.2

Other Social 9 6,563 494 642 608 346 0.2

Economic (Effic-

 iency Costs) 12 8,751 659 856 810 461 0.3

Economic (Trans-

 fer Costs) 22 16,043 1,208 1,570 1,486 845 0.6

Process 42 30,627 2,306 2,997 2,836 1,614 1.1

Total Regulatory 

16 of 21 08/26/15 8:46 AM
 Costs 93 67,817 5,105 6,637 6,280 3,574 2.4

 U.S. Totals

Type Regulation A B C Da Db Dc E

Environment 89 17,467 959 1,246 1,194 671 0.6

Other Social 47 9,224 506 658 630 354 0.3

Economic (Effic-

 iency Costs) 41 8,047 442 574 550 309 0.3

Economic (Trans-

 fer Costs) 75 14,719 808 1,050 1,006 566 0.5

Process 144 28,261 1,551 2,017 1,931 1,086 1.0

Total Regulatory 

 Costs 395 77,522 4,255 5,532 5,298 2,979 2.7

Numbers may not add due to rounding

Source: Thomas D. Hopkins. Profiles of Regulatory Costs, SBA Contract No.

SBAHQ-95-M-0298 (Draft Final Report, 1995).

_________________________________________________________________

 For the entire United States, the average cost of regulation per

employee in 1992 (1995 dollars) is:

 <20 employees $ 5,532

 20-499 employees $ 5,298

 >500 employees $ 2,979

 The smallest firms' regulatory costs per employee are l.86 times those

of the largest firms.

 For manufacturing, where the regulatory costs are the highest, the

cost per employee in 1992 is about double the average cost per employee

across the entire economy:

 <20 employees $ 9,016

 20-499 employees $10,605 

 >500 employees $ 4,855

 

 In the service industry, where the costs are the lowest, the costs per

employee in 1992 are:

 <20 employees $ 3,985 

 20-499 employees $ 3,558 

 >500 employees $ 2,146

 

_________________________________________________________________

The Office of Advocacy's Estimates 

 The Office of Advocacy believes that Hopkins overestimates the

allocation of the burdens on small firms. In his earlier study, about

one-third of the small firms reported only minor regulatory burdens.

Hopkins' use of the 30-percent greater-than-average figure per employee for

small firms excludes consideration of the firms with only minor costs. In

order to present a more balanced estimate of the allocation of burdens, the

Office of Advocacy projects that when firms with minor burdens are

included, a 20-percent greater-than-average figure is more appropriate for

small firms. Twenty percent below the average should be used for large

firms (Table 5).

17 of 21 08/26/15 8:46 AM
_________________________________________________________________

TABLE 5: Business Regulatory Burdens by Sector. 1992. The Advocacy Case

(1995 Dollars)

 A= Total Cost (billions)

 B= Cost per Firm

 C= Average Cost Per Employee

 D= Cost per Employee by Firm Size

 Da= <20

 Db= 20-499

 Dc= 500+

 E= Cost as a Percent of Receipts

 Manufacturing

Type Regulation A B C Da Db Dc E

Environment 62 188,909 3,413 4,095 4,617 2,730 1.8

Other Social 19 57,891 1,046 1,255 1,415 837 0.6

Economic (Effic-

 iency Costs) 7 21,328 385 462 521 308 0.2

Economic (Trans-

 fer Costs) 13 39,610 716 859 968 572 0.4

Process 25 76,173 1,376 1,651 1,862 1,101 0.7

Total Regulatory 

 Costs 126 389,911 6,936 8,323 9,382 5,549 3.7

 Trade 

Type Regulation A B C Da Db Dc E

Environment 9 6,125 349 419 390 279 0.2

Other Social 9 6,125 349 419 390 279 0.2

Economic (Effic-

 iency Costs) 10 6,806 388 466 433 310 0.2

Economic (Trans-

 fer Costs) 18 12,250 698 838 780 559 0.3

Process 35 23,819 1,358 1,629 1,517 1,086 0.6

Total Regulatory 

 Costs 82 55,805 3,181 3,817 3,554 2,545 1.4

 Services 

Type Regulation A B C Da Db Dc E

Environment 9 4,584 293 352 325 235 0.5

Other Social 9 4,584 293 352 325 235 0.5

Economic (Effic-

 iency Costs) 12 6,111 391 470 433 313 0.6

Economic (Trans-

 fer Costs) 22 11,204 717 861 794 574 1.1

Process 42 21,390 1,370 1,644 1,516 1,096 2.1

Total Regulatory 

 Costs 94 47,872 3,065 3,678 3,394 2,452 4.8

 Other 

Type Regulation A B C Da Db Dc E

Environment 9 6,563 494 593 570 395 0.2

18 of 21 08/26/15 8:46 AM
Other Social 9 6,563 494 593 570 395 0.2

Economic (Effic-

 iency Costs) 12 8,751 659 790 760 527 0.3

Economic (Trans-

 fer Costs) 22 16,043 1,208 1,449 1,393 966 0.6

Process 42 30,627 2,306 2,767 2,659 1,844 1.1

Total Regulatory 

 Costs 93 67,817 5,105 6,126 5,889 4,084 2.4

 U.S. Totals

Type Regulation A B C Da Db Dc E

Environment 89 17,467 959 1,151 1,115 767 0.6

Other Social 47 9,224 506 608 589 405 0.3

Economic (Effic-

 iency Costs) 41 8,047 442 530 514 353 0.3

Economic (Trans-

 fer Costs) 75 14,719 808 970 940 646 0.5

Process 144 28,261 1,551 1,862 1,805 1,241 1.0

Total Regulatory 

 Costs 395 77,522 4,255 5,106 4,950 3,404 2.7

Numbers may not add due to rounding

Source: Thomas D. Hopkins. Profiles of Regulatory Costs, SBA Contract No.

SBAHQ-95-M-0298 (Draft Final Report, 1995).

_________________________________________________________________

 Total regulatory costs per employee (in dollars) for all sectors are

shown below:

 <20 20-499 >500 Sm/Lg

 Hopkins' estimate 5,532 5,298 2,979 1.86

 Advocacy's estimate 5,106 4,950 3,404 1.50

 If total regulatory costs are divided by total sales (or receipts),

the differentials become even larger:

 <20 20-499 >500 Sm/Lg

 Hopkins' estimate .044 .040 .018 2.44

 Advocacy's estimate .040 .038 .021 1.90

The story is basically the same: Even after the most crucial assumption in

the analysis is adjusted in favor of large firms, small firms pay

significantly more than large firms per employee or dollar of sales. 

_________________________________________________________________ 

VII. THE FUTURE OF REGULATION 

 The average cost of regulation, paperwork, and taxpayer requirements

per employee in 1992, as estimated by Hopkins, is in the $5,400 range for

small firms and the $3,000 range for large firms. Although these figures

are only approximations, the difference between large and small firms --

some 80 percent -- is very significant. 

 The more conservative Advocacy estimates for the small firm are in the

$5,000 range and, for the large firm, some $3,400 per employee. Under

either scenario, this huge differential handicaps a new innovative

entrepreneur in competition with larger firms.

 The total regulatory costs for small and large firms are estimated in

19 of 21 08/26/15 8:46 AM
Table 6. Using the Hopkins scenario, firms with fewer than 500 employees

have a total regulatory, paperwork and tax compliance burden of $265

billion, while firms with more than 500 employees have a total burden of

$130 billion. Firms with fewer than 500 employees bear 67 percent of the

total burden of regulation, paperwork and tax compliance. 

 Using the more conservative Advocacy numbers, the total small firm

burden is $247 billion and the large firm burden is $148 billion; thus

small firms bear 63 percent of the total regulatory, paperwork and tax

compliance burden. Because small firms generate some 50 percent of the

employment and sales, this indicates that the burden is too heavy on the

smaller firms.

_________________________________________________________________

Table 6: Business Regulatory Costs of Employees, 1992 (in billions of 1995

dollars)

Type of Regulation Total Cost Per Employee by Firm Size

 <500 500+ Total

A. Hopkins' Case *

U.S. Total 265 130 395

 Environmental 60 29 89

 Other Social 32 15 47

 Economic-- Efficiency 28 13 41

 Economic-- Transfer 51 25 75

 Process 97 47 144

B. Advocacy's Case **

U.S. Total 247 148 395

 Environmental 56 33 89

 Other Social 29 18 47

 Economic-- Efficiency 26 15 41

 Economic-- Transfer 47 54 75

 Process 90 54 144

Numbers may not add due to rounding.

* Assumes small firms experience total employee costs that are

 30% higher than the average and that the largest firms

 experience total employee costs that are just 70% of the

 average.

** Assumes small firms experience total employee costs that are

 20% higher than the average and that the largest firms

 experience total employee costs that are just 80% of the

 average.

Source: Thomas D. Hopkins, Profiles of Regulatory Costs, SBA Contract No,

SBAHQ-95-M-0298 (Draft Final Report 1995)

_________________________________________________________________

 The data regarding the disproportionate impact on smaller firms

establish that regulatory costs are not being allocated fairly. If the

nation's goals are to generate employment and innovation, improve global

competitiveness, and encourage economic growth, government actions should

not impose disproportionate cost burdens on the small business sector to

solve other problems. The lesson here is that policymakers must implement

additional efforts to identify ways to minimize these burdens, while still

achieving the regulatory goals.

20 of 21 08/26/15 8:46 AM
 If there is a White House Conference on Small Business in the year

2005, many expect that small business owners will still list regulation,

paperwork, and taxes as a primary concern. It is unlikely that the

regulatory burden relative to the size of the economy will have changed

significantly. However, if the spirit of cooperation between the regulatory

agencies and the small business community continues well beyond the 1995

White House Conference on Small Business and if Congress continues to

revise the legislative mandates, there could be a significant downward

trend in the regulatory burden faced by small firms.

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