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Lafayette faculty are experts in their fields. Interests among the 195 members range across the full spectrum of humanistic, scientific, and technical knowledge. Lafayette encourages and supports faculty research and scholarship in the belief that such professional involvement extends the individual faculty member’s intellectual resources, strengthens and complements teaching effectiveness, facilitates student/faculty research, and contributes to the scholarly and professional communities outside the College. “Faculty: Expert” highlights a faculty member’s research. FACULTY: EXPERT W. Mark Crain Photography By David W. Coulter REGULATION: BIG IMPACT ON SMALL FIRMS Policymakers know a great deal about U.S. taxing and spending programs; the annual federal budget process and the Budget of the United States provide considerable detail regarding where the money comes from and how it is spent. Such fiscal information has been provided systematically for nearly a century and is in fact mandated by the Constitution (Article 1, Section 9). The same cannot be said for federal regulatory programs, which largely escaped any accounting scrutiny until quite limited tracking was mandated by Executive Order 11821 in 1974. . . . [The purpose of this study is] to identify the federal regulatory burden on small U.S. firms, and to assess whether and to what extent this burden disadvantages small businesses relative to their larger competitors. Underlying the significance of this assessment for the U.S. economy is the fact that 90 percent of all firms in the United States employ fewer than 20 employees. By comparison, large firms (those with 500 or more employees) account for only 0.3 percent of all U.S. firms. If federal regulations place a differentially large cost on small business, this would potentially cause inefficiencies in the structure of American enterprises and the relocation of production facilities to less regulated countries, and adversely affect the international competitiveness of domestically produced American products and services. All of these effects, of course, would have negative consequences for the U.S. labor market. Undue Burden [I]n 2004, U.S. federal government regulations cost an estimated $1.1 trillion, or 11 percent of national income. . . . The cost of complying with federal regulations in 2004 was more than half as large as total U.S. federal government receipts, which equaled 18 percent of national income. An interesting observation is that while federal government receipts as a share of the economy declined between 2000 and 2004, the federal regulatory burden grew. Combined, these two costs of federal government programs in 2004 amounted to 27 percent of national income, which represents a substantial burden on U.S. citizens and businesses. The findings . . . further indicate that in the distribution of federal regulatory costs, a disproportionately large share falls on small businesses. . . . Considering all federal regulations, all sectors of the U.S. economy, and all firm sizes, regulations cost $5,633 per employee per year. For firms with fewer than 20 employees, the cost is $7,647 per employee per year. The cost is $5,411 in medium-sized firms and $5,282 in large firms. Costs per employee thus appear to be at least 40 percent higher in small firms than in medium-sized and large firms. MARK CRAIN Mark Crain, William E. Simon ’52 Professor of Political Economy, is author of “The Impact of Regulatory Costs on Small Firms,” a peer-reviewed study, funded by the U.S. Small Business Administration, that finds a disproportionate regulatory compliance impact on small business. The research has been featured in business publications and mainstream media on both sides of the Atlantic, including The Wall Street Journal, Business Week, and Investor’s Business Daily. A former assistant to the director of the U.S. Office of Management and Budget, Crain teaches courses in political economy; industry, strategy, and policy; and public finance. In addition to regulation, his research interests include public finance, political economy of terrorism, and economic analysis of legislatures and elections. Crain joined the Lafayette faculty in 2004. He came to Lafayette from George Mason University, where he had served since 1982, most recently as director of the Center for Public Choice and professor of economics. He is author of more than 100 articles and seven books in the fields of economics and political science. His recent book, Volatile States, analyzes the evolution of public policy and its impact on economic and fiscal performance in the American states. He holds a Ph.D. in economics from Texas A&M University and B.S. in economics from University of Houston. The cost disadvantage faced by small businesses is driven largely by compliance with environmental regulations and tax-related paperwork. . . . Compliance with environmental regulations costs 364 percent more in small firms than in large firms. The cost of tax compliance is 67 percent higher in small firms than in large firms. . . . This report details the distribution of regulatory costs for five major sectors of the U.S. economy: manufacturing, trade (wholesale and retail), services, health care, and other (a residual category containing all enterprises not included in the other four). The sector-specific findings reveal that the disproportionate cost burden on small firms is particularly stark for the manufacturing sector. The compliance cost per employee for small manufacturers is at least double the compliance cost for medium-sized and large firms. . . . One way to illustrate the magnitude of the total cost of federal regulations is in relation to the number of U.S. households. . . . [T]his particular benchmark includes the total cost of regulations and makes no effort to distinguish between how much of this cost falls on individuals compared with businesses. It simply assumes that households (as consumers, workers, small business owners, shareholders, and so on) ultimately bear the entire burden of regulations. . . . [T]he total cost of federal regulations per household reached $10,172 in 2004, an increase of more than $1,000 per household since 2000 (in inflation-adjusted 2004 dollars). Between 2000 and 2004, the inflation-adjusted cost per household grew at an annualized rate of 2.7 percent, as compared with the 1.6 percent growth rate from 1995 to 2000. In essence, the total regulatory burden per household continued to grow, and to grow at an accelerating rate. . . . Distribution of Regulatory Costs [T]he annual total cost of all federal regulations in 2004 was $1.113 trillion. Of this amount, the annual direct burden on business is $648 billion. Economic regulations represent the most costly category, with a total cost of $591 billion, and with $295 billion falling initially on business. Environmental regulations represent the second most costly category in terms of total cost ($221 billion), and the cost apportioned to business is $144 billion. Compliance with the federal tax code is the third most costly category in terms of total costs ($195 billion), and the fourth most costly in terms of the burden on business ($103 billion). The cost of workplace regulations ranks last in terms of total cost ($106 billion), but because business bears all these costs, workplace regulations are the third most costly for the business sector ($106 billion). . . . Across Business Sectors Three measures of the regulatory burden are employed to assess the cost distribution among business sectors: cost per firm, cost per employee, and cost as a share of payroll expenses. [C]onsidering all U.S. businesses and all federal regulations, the total cost to the typical U.S. firm is nearly $115,000. The cost per employee for the typical U.S. firm is about $5,633. As a percent of firm payroll expenditures, the cost of all regulations in the typical U.S. firm equals 15 percent. To place this amount in perspective, it exceeds the employer contribution to the payroll tax for Social Security (OASDHI) and Medicare, which is 7.65 percent of wages. Indeed, 15 percent of payroll expenditures comes very close to the combined payroll taxes for OASDHI and Medicare paid by employers and employees, or self-employed individuals, which equals 15.3 percent. . . . The manufacturing sector in particular bears the highest total regulatory burden in terms of the cost per firm. The burden on the manufacturing sector ($548,077 per manufacturing firm) exceeds the burden on the second most costly sector (the “other” category at $170,835 per firm) by a factor of three. However, by the other two metrics—cost per employee and cost as a percent of payroll—the “other” category bears the highest burden. The cost per employee for firms in the “other” category is $17,175 as compared with the second highest sector (manufacturing) where the cost per employee is $10,175. The difference between the rankings based on cost per firm versus cost per employee is likely explained by the fact that these two sectors operate with different mixes of capital and labor. For example, among the “other” category are public utilities, firms that require huge capital investments relative to the number of employees. This means that the regulatory cost per worker rises in this sector relative to manufacturing establishments that typically have more employees per unit of capital investment than public utilities do. [R]egulatory costs are distributed much more evenly among the three remaining sectors: health care, services, and trade. In terms of the cost per firm, the burden on the health care sector is 18 percent higher than the service sector and 22 percent higher than the trade sector. However, in terms of the cost per employee, the burden on the health care sector is 18 percent less than on the service sector, and 12 percent less than on the trade sector. When the regulatory burden is gauged by “cost as a percent of payroll,” the health care sector fares slightly better than the service sector and the trade sector. In summary, some conclusions about the distribution of the regulatory burden among sectors depend on which metric one favors. However, the metrics uniformly indicate that the manufacturing sector and the “other” sector bear substantially higher regulatory costs compared with the health care, service, and trade sectors of the economy. . . . By Firm Size The distribution of compliance costs with respect to firm size classes differs across the five major business sectors. . . . The disproportionate cost burden on small firms is particularly large for the manufacturing sector. In that sector the estimated cost per employee for small firms is 118 percent higher than in medium-sized firms ($21,919 versus $10,042), and 151 percent higher than in large firms ($21,919 versus $8,748). Two types of regulations, environmental and tax compliance, drive the cost disadvantage faced by small manufacturing firms. . . . The cost of workplace regulations is 8 percent less in small manufacturing firms compared with medium-sized manufacturers, and 15 percent higher in small compared with large manufacturing firms. With regard to economic regulations, the burden falls disproportionately on large manufacturing firms. The burden of economic regulations on small firms is 12 percent lower than on medium-sized firms and 31 percent lower than on large firms. However, while some types of regulations disadvantage large firms relative to small, the combined impact of all regulations in the manufacturing sector puts the heaviest burden by far on small firms. . . .   Excerpted from The Impact of Regulatory Costs on Small Firms by W. Mark Crain, a study funded by the U.S. Small Business Administration’s Office of Advocacy. Released September 2005.