How the Regulatory State Cripples Small-Business

Politicians parrot on about small businesses being the backbone of the economy, only to pass the regulations that stifle them.

In 2024, several federal agencies instituted new regulations on small businesses. These agencies included the Financial Crimes Enforcement Network, the IRS, and the Consumer Financial Protection Bureau. The new restrictions add to an exponentially increasing mountain of mandates that small businesses have to comply with.

The United States is highly regulated compared to other Western market economies. The average U.S. state has 136,262 regulatory restrictions, compared to 30,910 in Canadian provinces/territories and 28,325 in Australian states. California has a whopping 403,774 regulations by itself. According to the U.S. Chamber of Commerce, over the past 60 years, “the U.S. population increased by 98% while the federal regulatory code increased by 850%.”

To make matters worse, this multitude of regulations has had a particularly severe effect on smaller enterprises. A study published in the Journal of Regulatory Economics found that regulations have a disproportionate impact on small businesses. But why are small businesses particularly harmed?

While complying with regulations may be difficult for large businesses, it is easier for companies with more capital, revenue, and dedicated legal departments to adapt and comply with new restrictions. However, small businesses don’t have that luxury. Because of tighter capital constraints and less legal assistance, small businesses find it hard to understand and adjust to novel regulations. Your local bakery likely doesn’t have the resources nor the legal knowledge to efficiently comply with a laundry list of convoluted government mandates.

For these reasons, compliance with mandates comes at a great cost to small enterprises. A study by the National Small Business Association found that small businesses spend an average of $83,019 per year on regulatory compliance. This is money that could have been devoted to employee compensation, research, or new products, but instead is lost on government bureaucracy. Since these companies already have smaller revenue streams than major corporations, this figure takes an even heavier toll.

Regulations also harm small businesses’ ability to generate innovation. The University of Rotterdam found a negative correlation between regulatory compliance costs and rates of innovation and research. If a profuse amount of resources must be devoted to complying with various binding restrictions, businesses have less time and money to devote to innovative endeavors.

Small business regulation can even increase racial inequality. During the COVID-19 lockdown, the number of black business owners fell by 41%, far more than non-minority groups. The Pacific Legal Foundation argues that minority-owned businesses were disproportionately affected because of the particularly stifling regulations within large cities where many of these businesses reside. The same policymakers who argue for concessions to be given to underprivileged minority groups simultaneously prevent their advancement through oppressing regulation.

Because of these policies, larger companies are given a disproportionate advantage in the market. Businesses with greater revenue streams already have the benefit of economies of scale, so giving them a regulatory edge all but assures their dominance. This has led to decade-low levels of small business optimism, with many enterprise owners predicting a decrease in net sales in the near future.

Small-Business Regulation: Another Example of Government Inefficiency

The disastrous effects of regulation on small businesses underscores a fundamental problem: the disconnect between centralized government and the intricate realities of entrepreneurship. While regulation aims for the protection of consumers in the market system, it inadvertently stifles innovation by hindering small business growth. Regulatory bodies lack a nuanced understanding of small businesses, which dooms their decisions to failure.

Regulators need a comprehensive grasp of the specific problems of entrepreneurship for a restriction to be effective. However, this understanding is outside the purview of a centralized government. This leads to one-size-fits-all solutions that are not effective for small businesses with diverse structures and products. Without knowledge of the day-to-day operations and unique constraints faced by these enterprises, regulatory interventions will perpetuate a cycle of unintended consequences.

Some regulations are important. Markets require constraints to prevent complete chaos. But when the average state has over 100,000 restrictions, so much so that small businesses can’t keep up with larger firms, the cure has become a curse. This is not a battle between small businesses and consumers. It’s a matter of government authorities believing they know better than entrepreneurs and enforcing this belief through repressive regulation. If the government does not grant entrepreneurial freedom which is the foundation of economic growth, everyone will suffer, not just small businesses. Let’s hope they act before it’s too late.