Regulation: Costs, Incentives, and the Need for Reform

By SBE Council at 19 October, 2016, 9:43 am

REPORT SUMMARY

(Access the full report here)

By Raymond Keating, Chief Economist

Small Business & Entrepreneurship Council

October 2016

Why does government regulate the private sector seemingly without regard to the significant costs? Not that long ago, the standard answer from an economics perspective would have been that “market failure” existed, and therefore, government must take corrective action. However, improved analytical thinking on the economics of government, coupled with a better understanding of economic history, have provided a more realistic assessment on the costs and effectiveness, or lack of effectiveness, of government’s regulatory undertakings. It turns out that the government failure generated by regulations often turns out costlier than the so-called market failure targeted for correction.

Hyper-Regulation Under President Obama. Overreaching government regulation is not a recent development. For example, the 1930s, and much of the 1960s and 1970s were periods of heavy government regulation. In recent years, the United States has been caught in another era of active – even hyper-active – regulatory undertakings, especially since 2008.

The Costs of Regulation. Assorted studies make clear the significant costs imposed by the U.S. regulatory system in terms of lost GDP, costs imposed on small businesses, declining entrepreneurship, reduced job creation, and reduced or restrained investment and productivity. Studies over the past 25 years have consistently found that the cost of regulatory compliance disproportionately affects small firms. Indeed, overly burdensome and complex regulations, along with high costs and uncertainties impact business decisions.

Regulation Gone Awry: The Great Depression Example. It was long held that excesses of the free market caused the Great Depression, and our economy was rescued by government action. That has changed, with various economists and historians more seriously considering the impact that government activism, including regulation, had in triggering, deepening and extending the Great Depression. Clearly, regulatory costs and uncertainty discouraged investment, hiring and risk taking, thereby undermining recovery. As one economist put it: “New taxes had been imposed, and some were then removed; increasing regulation of businesses had reduced businesses’ ability to act independently and raise capital; and new legislation had reduced their freedom in hiring and employing labor.”

Recent parallels to the Great Depression are unnerving. It’s clear that increased regulation, along with misguided tax increases and other government escapades raised costs, created uncertainty, deepened the 2007-to-2009 recession, and helped make the subsequent recovery one of the worst on record.

The Incentives to Regulate. Given improved understandings of the costs of regulation, then why do elected officials and their appointees partake in regulatory activism? The answer is the incentives at work in politics and government. For example, few incentives exist for voters to understand the extent and cost of regulation, while incentives are strong for special interests to spend heavily and vote based on the regulatory actions they seek. There is a strong bias among elected officials to regulate, as opposed to taking other types of action or no action at all. Also, significant incentives for government bureaucrats exist to expand agency goals, and push for larger budgets, increased power and control, and bigger staffs.

Institutional Reforms Needed. What can be done to correct this bias towards regulation? Unfortunately, under the current incentive structure, any positive gains from deregulation, for example, almost seem destined to be short-lived. Instead, institutional and constitutional limitations, or checks and balances, are needed to achieve greater balance when it comes to imposing regulations. These include:

Improving Analysis of Regulatory Impacts on Small Businesses. Regulatory agencies should be required to examine not just regulations’ direct economic impacts on small businesses, but also their indirect effects, such as higher energy and commodity prices that can result from onerous rules. Regulators must also seek the input and feedback of small businesses at the very start of rulemakings, and all agencies should be required to engage with the small business community during the rulemaking process.

Independent Congressional Regulatory Analysis. Rather than relying on analyses from the Office of Management and Budget or agencies themselves, Congress needs an independent means to analyze rules and regulations, such as subjecting them to rigorous cost-benefit analysis, especially for the consideration of regulatory legislation, and for purposes of evaluating existing rules and regulations. 

Congressional Approval of Rules and Regulations. Given that Congress has incentives to pass regulatory measures, but leave the actual details of creating and imposing rules, mandates and regulations to agency bureaucrats, the system amounts to regulation without representation. It is critical to establish full responsibility for regulating to Congress. Therefore, before being finalized and imposed, all rules and regulations – at least “major rules” – should be subject to votes in Congress. 

Sunsetting Rules and Regulations. All new and existing rules and regulations should have a definitive lifespan, so that Congress is required to re-evaluate regulations after a certain period of time.

Greater Use of Formal Rulemakings. For rules that impose significant costs to the economy, federal agencies should be required to engage in so-called “formal rulemakings.” These are similar to court proceedings, in which bureaucrats, and the scientific and other economic claims they invoke, are scrutinized and cross-examined by opposing parties. 

Strengthening the Integrity of Scientific Data and Increasing Transparency. Agencies such as EPA should be required to publicly disclose any scientific studies or data used to justify a federal rulemaking before it can be proposed, disseminated, or finalized. Agencies should ensure that such studies are the best available and their conclusions fully reproducible.

Regulatory Budget. More information and greater transparency regarding federal regulations is desirable, and a regulatory budget, if properly done, could be a tool to achieve such goals.

Supermajority Votes. Given the costs of regulatory burdens on businesses, entrepreneurs, workers, and investors, requiring a supermajority vote (such as 60 percent in each chamber of Congress) to pass bills imposing major regulations on businesses, entrepreneurs and investors would be a check on the bias to regulate.

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