Estimating the Impact of Regulation on Business

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Scholars claim that the cost of regulatory compliance disproportionately affects medium-sized firms.

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Regulation is costly. The federal government estimates that regulations cost American businesses roughly $300 billion annually, only $53 billion less than firms spend on corporate income taxes. But do all businesses feel the same economic pressure from regulations?

According to one group of scholars, no.

In a recent study, Francesco Trebbi from the University of California, Berkley and Miao Ben Zhang and Michael Simkovic from the University of Southern California, develop a new method of measuring the costs for businesses to comply with regulations and find that regulations cost the American economy $289 billion annually, disproportionately affecting medium-sized firms.

Scholars and politicians continue to debate the exact extent of the cost of regulation on companies. Some scholars estimate that American businesses spend an additional $700 billion annually to comply with regulations. The Office of Information and Regulatory Affairs, however, estimates that regulation costs firms closer to $300 billion annually.

Federal, state, and local authorities subject firms to a complex web of regulations, making it very difficult to estimate the cost of overlapping regulations for any particular firm or industry, Trebbi, Zhang, and Simkovic claim.

To overcome this difficulty, Trebbi, Zhang, and Simkovic propose a novel method of estimating the costs of regulatory compliance, which emphasizes the impact of regulation on the tasks employees of a company perform and subsequent labor expenses. Since companies report that 93 percent of their regulatory compliance costs are labor-related, Trebbi, Zhang, and Simokovic argue that emphasizing the impact of regulations on labor provides a more consistent and accurate measure of the costs of regulation.

Trebbi, Zhang, and Simkovic use data collected from the U.S. Bureau of Labor Statistics from individual firms about the tasks employees perform and the time employees spend on each task. They argue their method allows them to calculate the impact of regulation at the firm level and to make inferences about the impact of regulation across different types of firms.

Using this method, Trebbi, Zhang, and Simkovic estimate that regulations cost U.S. firms $239 billion annually in labor-related costs alone, and generated an additional $50 billion in capital and other expenses. Furthermore, they find that regulation did not affect all firms equally across their model. Compliance costs for medium-sized firms—which they define as firms with around 500 employees—are nearly 40 percent higher than those for small or large firms, they predict.

As a firm grows from a smaller firm to a medium-sized firm, its costs of complying with regulations increase, but as a firm grows from a medium firm to a larger firm, its costs of compliance decrease, according to Trebbi, Zhang, and Simkovic. Medium-sized firms, experienced 47 percent more costs than small firms and 18 percent more than large firms in order to comply with regulations.

Trebbi, Zhang, and Simkovic assert that three forces may impact the distribution of regulatory costs across firms: fixed costs of compliance, tiered systems of regulation, and disparate enforcement.

First, fixed costs of compliance, or situations where a regulation imposes the same cost on a firm regardless of its size, contributes to the decrease in compliance costs as a firm transitions from a medium-sized firm to a larger firm, according to Trebbi, Zhang, and Simkovic.

They explain that regulation costs medium-sized firms more than larger firms because much of the costs of regulatory compliance are fixed, and larger companies with more labor resources are better equipped to absorb these costs. Trebbi, Zhang, and Simkovic observe that larger companies systematically hire more compliance officers than smaller companies.

Second, small firms also spend less on compliance than medium firms because of tiered regulatory schemes—regulations that intentionally impose greater regulatory requirements on medium and larger firms.

For example, securities regulations under the Securities and Exchange Acts only apply to publicly traded corporations, which are typically large firms. These tiered regulatory schemes excuse smaller, non-public firms from the requirements of many regulations to which medium and larger firms are subject, they claim.

Cost differences associated with different regulatory requirements for small and medium firms accounted for 97 percent of the overall difference in regulatory costs between small and medium firms, according to the model generated by Trebbi, Zhang, and Simkovic.

Third, Trebbi, Zhang, and Simkovic argue that selective enforcement—when regulators selectively enforce regulations only against larger firms—could account for the increased costs of regulations for medium-sized firms.

They note, however, there is little evidence to prove disparate enforcement. Indeed, Trebbi, Zhang, and Simkovic found that the costs of regulatory enforcement did not vary significantly across firms after controlling for the size of the firm.

Trebbi, Zhang, and Simkovic ultimately conclude that tiered regulatory regimes likely contribute to cost discrepancies among firms more than selective enforcement. Rather than regulators intentionally pursuing enforcement actions against larger firms while ignoring smaller firms, many regulations simply place greater regulatory obligations on large and medium firms, they predict. By the time a company grows from a medium-sized firm to a large firm, however, it can begin to centralize the costs of compliance, in turn reducing the costs of regulation, they claim.

Trebbi, Zhang, and Simkovic urge policy makers to consider the distributional impact of regulations on companies as they debate the costs of particular regulations.