Small Business’s Problem With Government Regulation

Government regulation adversely affects small business.

While the finding may be intuitively obvious (to those not in government), World Bank economists recently showed that entrepreneurs create fewer new businesses in countries with regulations that make starting companies more difficult.

Reducing regulation also enhances the performance of small companies. For instance, researchers found that efforts to simplify the new business formation process in Mexico boosted small business employment by nearly 3 percent.

Why Regulation is a Problem
Economists believe that regulation hurts small business in four ways. First, as Nicole and Mark Crain of Lafayette University explain, regulatory compliance exerts a disproportionately large burden on small companies because the fixed costs of adhering to rules can be spread out over more revenue in large firms than in small ones. Crain and Crain estimated the per employee cost of complying with Federal regulations at $10,585 for businesses with fewer than 20 employees but only $7,755 for businesses with more than 499 workers.

Second, government regulations make small businesses less competitive against foreign competition. As Crain and Crain explain, government regulations create “inefficiencies in the structure of American enterprises;” adversely affecting “the international competitiveness of domestically produced American products and services;” and leading to “the relocation of production facilities to less regulated countries.”

Third, adding regulations creates uncertainty, which keeps small business owners from investing and hiring. Because few business owners can predict the scope or impact of new regulations, they often delay buying capital equipment or adding workers as they wait to see the impact of new regulation.

Fourth, new regulations often have unintended consequences. Consider the new health care law, which requires businesses to file 1099 forms for all payments to a single payee exceeding $600 per year beginning in 2012. The effort to increase health insurance coverage has resulted in an unrelated tax filing that imposes heavy compliance costs on small business owners, an outcome that even surprised many in Congress who voted to pass the law.

Our Poor Showing is Getting Worse
The United States does not compare well with many industrialized nations on the dimension of small business regulation. The Organization for Economic Cooperation and Development (OECD) found that the U.S. had higher regulatory barriers to entrepreneurship, greater administrative burdens on small business owners, and higher barriers to competition than a number of other industrialized countries.

The regulatory burdens on U.S. small business are getting worse. Both the World Bank and the Global Entrepreneurship Monitor report that U.S. entrepreneurs faced more start up red tape in 2007 than in 2003.

American small businesses are now being adversely affected by two massive new laws: the Patient Protection and Affordable Care Act and Dodd-Frank Wall Street Reform and Consumer Protection Act. A recent Discover Card survey of small business owners indicates almost half of small business owners believe that new health care law is harmful to their businesses and only a little more than one quarter see it as beneficial. Respondents to a 2010 Discover Card survey showed that 55 percent of small business owners believe that the financial reform bill will make small business finance more difficult, while only 9 percent think the new law will make it easier.

We Need More Action
Our leaders talk of reducing the regulatory burden on small businesses. In a recent Wall Street Journal article, 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….Today I am directing federal agencies to do more to account for—and reduce—the burdens regulations may place on small businesses.”

Of course, some of us remember when former President Bush said in his 2004 State of the Union speech, “Our agenda for jobs and growth must help small business owners and employees with relief from needless federal regulation…”

Perhaps I should stop quoting Presidents and start quoting country singers. As Toby Keith said what we need is “a little less talk and a lot more action.”

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Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

12 Reactions
  1. Regulations usually begin with a specific use case in mind. Enron led to Sarbanes-Oxley. The Wall Street meltdown is leading to the Dodd-Frank Wall Street Reform and Consumer Protection Act. Politicians find a high-profile case and jump on it to “protect the consumer.” However, these protections come at a cost. Just like national security comes at the cost of maintaining a military, this type of consumer safety comes at the price of regulations. That means you have to employ government employees to ensure compliance, which can lead to whole agencies with management and overhead. Businesses have to comply, thus requiring more resources. All these expenses to produce nothing.

    At some point voters will need to start taking more responsibility for their own protection and quit relying on the government to protect them, because when you ask the government to do it for you, the price tag usually ends up being too high.

    PS Love the Toby Keith quote.

  2. I think these reforms are needed and welcomed, however some of the laws and regulations as outline are very harmful to the growth of small businesses. More credits need to placed on provided any kind of health care without any kind of a minimum requirement.


  3. It absolutely true that the more regulations you have, the harder it becomes to start a new business, as you have mentioned, there are so many rules and regulations on these small companies that there is too much risk involved to do investments. However, I think it’s so important that these regulations are toned down to encourage more people to do business as these small businesses always boost the economy. Thanks for sharing!

    Riya Sam
    Training for

  4. When one person is “protected” by the any form of government (local, state, federal) another person is exploited. When you give special priviledges to one group, another group has to pay for it.

  5. Five years on, and the matter of regulation strangling enterprise is still apparent and getting worse. Look carefully and you’ll see that politicians everywhere make speeches about reducing regulation on small businesses and then sign legislation into law that does the exact opposite.

    This article by Antony Davies (May 2014) does a good job of summarizing the current situation.

    Small enterprise and micro-trade is being methodically ground-down by State regulators. Trade is becoming so expensive and complex due to regulatory and tax burdens. It’s now quite probable that, in the foreseeable future, only big companies and big governments will be able to afford to participate in trade. Which puts budding entrepreneurs in the same group as those “retail investors” who buy stocks thinking that they can make money when in fact they are being methodically fleeced by insiders: the majority of entrepreneurs starting out today will lose their savings and then (quietly, to avoid embarrassment) go back and work for a big company or the government to make ends meet.

    The era of independent enterprise is over; I estimate that it will be at least two or three generations before it begins to make a return–not in my lifetime, anyway. The weight of regulation has become so heavy and so omnipotent that it’s now piercingly expensive and/or risky to do anything. The regulators will not voluntarily withdraw their laws for the same reasons that turkeys don’t vote for Christmas. The corollary is that the “better” option is to do nothing. The implications of this are profound and too complex to discuss here.

    Suffice to say that, during the post WWII Communist era, the USSR’s political institutions wanted to own everything and that didn’t work out very well (though it caused plenty of human suffering). Today, States want to regulate everything which is tantamount to the same thing: “shareholders” get to own the companies, but the State dictates how those companies operate (regulations), who can work for them and how they can work for them (licenses and more regulations).

    Take a moment to reflect on what is happening around you.

  6. Besides the two regularions mentioned above, (Dodd-Frank and Sarbanes) what others cause problems for small businesses? I’m not terribly sympathetic to the complaint about having to file a report regarding the Affordable Care Act.If the business is very small, they don’t have to offer health insurance. But I don’t own a small business. Do restaurant owners finds health inspections onerous? Is there a complaint about filing social security contributions and paperwork? I’d really be more sympathetic if small business owners listed what regulations are unfair to them and if the cost couldn’t be covered by a slight raise in prices. For example, the owner of a coffee shop could raise the price of a nice cup of coffee by 25-50 cents and likely not lose a single customer. We purposely shop at locally-owned businesses when possible and hate to see them close, but I’m strongly in favor of health inspections, the Affordable Care Act, paying local taxes, removing ice from sidewalks in front of the store, etc. I would honestly like to know specifically what regulations hurt their bottom line and are not protective of both the business and the customers.