Reforming Regulation to Keep America's Small Businesses Competitive

Testimony of

James L. Gattuso

Research Fellow in Regulatory Policy

The Heritage Foundation

To

The Subcommittee on Regulatory Reform and Oversight

Committee on Small Business

United States House of Representatives

On

"Reforming Regulation to Keep America's Small Businesses Competitive"

May 20, 2004

Chairman Schrock and members of the Subcommittee, thank you for the opportunity to testify today on this important topic.  

Costs of regulation. Every year, Americans are reminded of the costs of federal taxation when they filed their income tax returns with the IRS, and see a clear and specific bottom line telling them how much they paid to Washington. Not so with the cost of regulation. These costs are hidden - embedded in the prices of products and services, reduced innovation, and lost opportunities.  

Yet, by any reckoning, these costs are staggering. According to the Office of Management and Budget, regulations adopted in the last ten years alone cost Americans some $34-38 billion annually. All federal regulations, OMB estimates, could be costing ten times that much, or some $380 billion.

This estimate, however, is likely a vast understatement. According to a comprehensive study conducted by economist Mark Crain and Thomas Hopkins for the Small Business Administration, regulations cost Americans $843 billion in 2000, or over $8,000 per household.[1] That is almost half the amount collected in federal taxes, and nearly as much as Americans paid in personal income taxes ($999 billion).                               Put another way, the total is about 10 percent of America's gross domestic product - and more than half the output of the U.S. manufacturing sector.

                                            
Crain and Hopkins also found that that these regulatory costs fell disproportionately on small businesses. In total, they found that firms employing fewer than 20 people faced regulatory costs of almost $7,000 per employee, compared to an average of $4,700 for all firms.

It should be noted, however, that even these numbers are estimates - the full impact of regulation is likely even higher. Crain and Hopkins, for instance, do not include indirect burdens in their study. For instance, a regulation that increases the cost of energy also would increase the cost of products that require energy to produce. Those secondary costs do not appear in the Crain and Hopkins totals.

Perhaps more important, some costs are by their nature unknowable. For many economic regulations, for instance, the major cost may not be any direct burden on consumers or businesses, but constraints on innovation. There simply is no way to assess such losses - you can't measure inventions that never were created. In today's 21st century economy, these unmeasurable costs are perhaps more harmful than the measurable burdens.

The economic harm from regulatory burdens is substantial - reducing economic growth, slowing job growth, and reducing Americans' income. The actual effects vary tremendously, based upon the type of regulation at issue. But the overall result is clear. Most recently, the World Bank released a study of regulation around the world - with a particular emphasis on rules critical to start-up enterprises, such as entry restrictions. The report underlined the connection between economic growth and regulation, finding that "[h]eavier regulation is generally associated with more unemployed people, corruption, less productivity and investment."[2]

Americans can take heart that their regulatory burden is far less than much of the world. Yet, we shouldn't be too comfortable. The study offered three alternative methods of rankings of "least regulated" countries. The U.S. was in the top ten in only one, and on that we were tenth.

Bush Administration efforts. To its credit, the Bush Administration has recognized the problem of regulation, particularly in regard to small business, the traditional engine of growth and job creation in the economy. Over the past few years, the Office of Information and Regulatory Affairs, the OMB unit that oversees executive branch regulation, has been revitalized - taking a harder look at proposed new regulations, and implementing new standards for agency analyses of new rules. In regard to small business, the President signed a new executive order strengthening requirements for agencies to assess the small business impact of proposed new rules, and the expanding the role of the SBA's Office of Advocacy in that process. 

This has led to some successes. The Office of Advocacy in particular reports that some $6 billion in potential new burdens were avoided in 2003 due to evaluations of small business impacts. Yet, much as I would like to believe that the regulatory problem is being solved, it is not. While the growth of regulation may have slowed, burdens still appear to be growing - not shrinking.

Continuing growth of regulation. The 2003 edition of the Code of Federal Regulations, for instance, weighed in at a whopping 144,177 pages, about a thousand pages less than in 2002, but still four percent more than when President Bush took office in 2000. This overall increase was led by nine percent increase in the sections on the environment and transportation.

Similarly, the number of federal rulemaking proceedings which increase burdens on the private sector still substantially outnumber those which decrease burdens. Since 1996, the General Accounting Office has reported to Congress on major rules promulgated by agencies, as required under the Congressional Review Act. Excluding from this list those that are "budgetary" in nature - i.e. establishing terms and conditions for spending programs[3], and excluding those that did not clearly increase or decrease burdens, leaves 30 major final rulemakings from the start of the Bush Administration to the end of 2003.[4] Of these, 21 - or 70 percent -- increased regulation.

The record was even more lopsided during the Clinton years. From 1997 through the end of the Clinton Administration, some 106 such rulemakings were finalized - nearly twice as many per year -- with over 75 percent increasing regulation. Taking out rules adopted by independent agencies, the portion increasing burdens during the Clinton Administration hits 92.5 percent. Bush's executive branch actions increased burdens 74 percent of the time.

These numbers admittedly are only a rough measure of regulatory trends. However, they indicate that - while regulatory growth has been curbed during the Bush Administration - it has not been stopped. Regulation is still expanding, not shrinking. 

Small business and regulation. It should be noted that while small businesses bear a disproportionate share of the regulatory burden, the issue should not be considered too narrowly in terms of small business. Most of the regulatory harm suffered by small business is not from regulations imposed specifically on such businesses, or even applied to them directly. Small businesses, like individual Americans, suffer from the higher prices, reduced economic activity and hindered innovation caused by excessive regulation. In this way, even regulation of "big" businesses such as telephone companies and electric utilities harms small business.

In addition, it should be remembered that the interests of small businesses are not always the same as consumers as a whole. Regulations that artificially protect small businesses can therefore be as harmful to Americans as those that hinder small businesses. In fact, many of the most heated controversies in regulatory policies have involved rules that limit competition to small businesses - ranging from insurance agents to car dealers to law firms - at the expense of the public as a whole. The goal of policymakers should be to eliminate unnecessary barriers, rather than provide regulatory advantage to, any enterprise. 

Pending legislation. What then, can be done to curb unnecessary regulation? Several proposals are pending in Congress that would at least represent small steps in the right direction. One, H.R. 2345, would strengthen the Regulatory Flexibility Act in a number of ways, increasing requirements for agencies to analyze small business effects before promulgating regulations, and increasing the authority of the SBA's Office of Advocacy in a number of ways. Among other things, it would require agencies to evaluate the indirect, as well as direct, effects of regulation on small business. This is a positive step, for the reasons outlined above. 

The legislation would also require agencies to periodically review existing rules for small business impacts. This also would be a positive step, and is similar to a provision of the Telecommunications Act of 1996 that requires the FCC to review its regulations every two years. Importantly, that provision explicitly requires the FCC to repeal or modify any regulation it finds is not in the public interest. A similar requirement would be helpful in this legislation.

In addition to H.R. 2345, the Government Reform Committee has reported H.R. 2432, by Rep. Doug Ose (R-CA). This legislation is primarily aimed at improving regulatory accounting - the calculation of the costs and benefits of regulation. Among other things, the legislation requires each agency to report to OMB each year on the costs and benefits of its regulations, and provides for a pilot program on "regulatory budgets."

Problems with regulatory accounting. Steps to improve the valuation and reporting of the costs and benefits of regulation are much needed. Despite improvements over the past few years in the federal government's ability to assess such costs and benefits - due in large part to efforts by OMB's Office of Information and Regulatory Affairs - the information produced by regulators on the impact of their regulations is still incomplete, inconsistent, and often unreliable.  A large number of major regulations are routinely adopted without a quantification of both costs and benefits. According to OIRA, of 12 major non-budgetary rules it reviewed in 2003, costs and benefits were only quantified for six. In addition, at least nine major regulations were promulgated without OIRA review (primarily by independent agencies). Eight of these failed to quantify costs and benefits. The net result was that of at least 21 regulatory actions, costs and benefits were quantified for only seven - a rate of 33 percent. As a result, even though OMB is required by law to report annually on the costs and benefits of regulation, those numbers actually cover only a small portion of regulatory activity.

Moreover, even when costs and benefits are quantified, the numbers are based upon analyses performed by regulatory agencies themselves, as part of their justification for their rules. And despite efforts by OIRA to make the analyses uniform, they have varied substantially in quality and methodology. Although analyses are approved by OIRA as part of the review process, they do not present a reliable or consistent assessment of regulatory costs.

Steps to improve regulatory accounting are much needed. Simply put, policymakers and consumers deserve to be told more about the costs being imposed on them by federal regulators. Requirements, such as those in H.R. 2345 to expand analysis and reporting of costs and benefits, could be beneficial. At the same time, we need to recognize the limitations of such reforms. 

Certainly, agencies should be required to provide more analysis. But to the extent that the same people who wrote the rules provide the analysis, the result will be a too-rosy view of their efficacy. And, as mentioned above, even the best analysis cannot quantify every impact of a regulation - especially in innovative industries. Moreover, even perfect regulatory accounting would not ensure good regulatory decision-making. As anyone who has seen regulatory debates first-hand can verify, ultimately decisions are influenced for good or bad by the facts of the particular case, the values, principles and priorities of the decision-makers, and (yes) even politics. 

Additional reform proposals. For these reasons, steps are needed to ensure independent analysis of regulations, to ensure that the risks of overregulation are fully considered at every stage of the regulatory process. Such steps could include:

1.      Establishment of an independent Office of Regulatory Analysis. Such an office - charged with providing Congress with information on the cost and impact of, and alternatives to - regulation -- would provide an independent source of analysis on regulation. The model for this new office would be the Congressional Budget Office, with provides Congress with information on spending programs, and acts as both a complement to, and check on, the Office of Management and Budget.[5]

2.      Establish regulatory review offices, or "mini-OIRA's" within each regulatory agency. Consideration of the costs of regulation should not begin when a proposal leaves an agency, but should take place within an agency as well. To be an effective check, however, analysis should be from outside the office or bureau implementing the decision. One model for this is the office I served in Office of Plans and Policy at the FCC, which reviewed every item presented before the Commission, and provided comments to the Chairman and Commissioners. 

3.      Designation of "regulatory reform czars" at each agency. Sometimes, the best way to ensure that an issue is given consideration is to confer responsibility on an individual for making sure that is done. In 1992, as part of the first Bush Administration's regulatory review executive order, each agency was required to designate such officers, known informally as "regulatory czars." No new staff positions were created, as the individuals typically were the general counsels or policy directors of the agencies, but ensuring regulatory restraint became part of their job description. Certainly, not every one produced a success story, but some did become jealous advocates of reform, making the case for better regulation inside their agencies.  

4. Require independent agencies to submit analyses to OMB. Independent agencies such as the Federal Communications Commission and Securities and Exchange Commission produce a substantial share of the major rules finalized each year - seven of 21 for FY2003. The overall impact of these agencies is even greater, as they cover some of the economy's most dynamic and vital sectors. Yet, these agencies' rules are not subject to outside rule before they are promulgated, and only rarely are their costs and benefits analyzed. The problem could be resolved by putting independent agencies under the requirements of Executive Order 12866. If that cannot be done, Congress should at least require these agencies to prepare regulatory analyses of all planned significant rules, and to forward the analyses to OIRA for non-binding review.

5. Require congressional approval of major regulations that place new burdens on the private sector. Under the Congressional Review Act, Congress has the ability to veto new regulations coming from agencies. To date, however, that authority has only been used once - to stop a new ergonomics rules from taking affect. Our system of government requires that Congress take responsibility for new rules imposed on society. Congressional review and approval of major new burdens should be required. (Rep. J.D. Hayworth has proposed such a step in H.R. 110.)

Conclusion. There is no "magic bullet" for controlling the continuing growth of regulation. The proposals now pending in Congress do largely move in the right direction, but much more is needed to solve the problem. 

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