Critics argue that red tape drives up the cost of living, and that the costs of bureaucratic rules governing business escalate every year. Both direct and indirect costs must be considered to evaluate this argument.
Direct Costs of Regulation
The direct costs of regulation include the administrative costs of operating regulatory agencies and the compliance costs incurred by regulated entities.
Direct costs of regulation include (a) administrative costs to the government (employee salaries, office supplies, and other "overhead" expenses), and (b) compliance costs incurred by regulated entities (primarily the private sector, but also by other governmental units that must comply with regulations).
Some recent studies have estimated some direct costs of federal regulation. These researchers found that compliance costs were many times larger than administrative costs. Extrapolating their results to 1995, nearly $400-500 billion is now absorbed annually to meet federal regulations---roughly one-third of U.S. private investment, or nearly $2,000 per U.S. citizen. In 1994, a task force headed by Vice President Gore was charged with developing a plan to “reinvent government.” Identifying ways to eliminate wasteful federal programs and inefficient red tape was a centerpiece in this study.
Indirect Costs of Regulation
Government budget outlays have swollen as public demands for regulatory programs have grown. The costs of government go far beyond the national budget, however, because even programs with laudable objectives may generate indirect costs through their effects on workers, consumers, and other participants on the economic stage.
Indirect costs of regulation are undesirable changes in behavior in response to regulations, and resemble the excess burdens of taxation.
Consider unemployment compensation. Many workers effectively receive paid vacations if they are laid off. Unemployment compensation is largely untaxed and is often as high as 80 percent of a worker's take-home wage. Thus, this program creates incentives for some people to work irregularly, sticking the burden on workers with stable jobs.
Taxes are also distortive. Many employee benefits are disguised as legitimate business expenses. Firms offer tax-free fringe benefits to their employees because, were these benefits paid in cash, employees' income taxes would rise. Thus, many employees select more extensive health and dental care coverage than they would if these benefits were taxable. Further, some employees drive company cars that are newer and grander than cars they would buy for themselves, and eat more elaborate lunches than they would if they were paying their own tabs.
Indirect costs are incurred whenever people adjust to policies in ways not intended by policymakers. It may be that regulations are complex because many people find ways to avoid simpler rules. The complicated lives we lead while adjusting to a maze of bureaucratic rules are among the indirect costs of government. When all direct and indirect costs of all federal, state, and local regulations are considered, regulation probably absorbs 5 to 10 percent of our national income. But costs are only one side of the regulatory equation; a balanced view would require estimates of the benefits of government regulation or deregulation. Unfortunately, data are not available that would permit scientific estimates of the benefits of regulation.
There is a consensus that some regulation is necessary. But when has regulation gone too far? Recently, the Federal and Drug Administration (FDA) killed the McCurdy Fish Company (a small herring smokehouse in Maine). This closure resulted from regulations that required fish to be eviscerated before salting and smoking. The regulations grew out of problems with freshwater whitefish and officials insisted that it made sense to apply the standards to all fish. Ocean herring, however, are small saltwater fish that are processed in a concentrated brine solution that kills potential toxins. Further, the regulations apply only to fish processed within the United States, allowing foreign suppliers to process herring in the same manner that closed McCrudy.
These examples, several recent studies, and several presidential study groups all attest to the costliness of regulation, which is ultimately reflected in lower business profits, less income to workers, and higher rates of unemployment. In the neighborhood of $500 billion is devoted to regulatory activity. Big government may create problems just as enormous as those posed by big business or big labor.
Deregulation and Reregulation
Politicians often pledge to reduce government intervention in the private sector. The past 18 years have ushered in substantial deregulation of trucking, airlines, banking, and a few other industries. Increased competition in these industries pushed prices down sharply. The economic pressures generated from airline deregulation led to many changes in the industry, including Continental Airlines' use of the federal bankruptcy statute to void its union contracts and the closure of many unprofitable airlines.
Regulation often involves a complex combination of price and entry restrictions that can lead to higher prices and less service. Moreover, the competition among regulated firms tends to ignore pricing and to be especially focused on advertising, product quality, or new product development. Regulation is often a compromise among conflicting public interest, industry interest, and bureaucratic objectives, which makes the results of deregulation somewhat unpredictable. Deregulation of the American Telephone and Telegraph Company taught us that deregulating the provision of a good or service often involves submarkets that may be quite different from each other. Deregulation that works well in one submarket may be less successful in another.
That deregulation may be disruptive is evidenced by the turmoil and declines in national income throughout much of Eastern Europe as tightly regimented economies begin uneasy transitions toward less regulation. On a slightly smaller scale, almost every form of deregulation entails a certain amount of costly confusion. This is especially true when only one side of balanced sets of regulations is eliminated.
The recent U.S. savings-and-loan crisis is an example. Deregulation advocates failed to consider the moral hazards that arise if financial institutions are given a wide latitude in loans while a government insurance program guarantees the first $100,000 of each account in insured institutions. The lesson of this calamity (which will ultimately cost American taxpayers a total estimated at between $120 billion and $200 billion) is not that this deregulation was a big mistake but, rather, that deregulation must be studied carefully so that such problems can be anticipated and remedied. The S&Ls that collapsed in the late 1980s probably would not have had as much money to loan if insurance on deposits had been eliminated for financial intermediaries that chose risky investment strategies and if this absence of insurance had been widely publicized.
Deregulation generally stimulates competition, a fact that many people find discomforting. For example, almost every major airline crash generates calls for reregulation of the airlines. This reaction ignores the fact that deregulation affected the Civil Aviation Board's command over rate structures and ability to limit competition, not the FAA's control over safety issues. In fact, a recent study by the FAA indicates that airline safety has actually improved since U.S. skyways were deregulated. The number of passenger fatalities per 100 million miles flown has dropped steadily since 1977. But critics point out that this safety record may prove illusory as the fleet ages because competition has reduced the funds available to purchase new aircraft. Competition in the airlines has reduced prices, putting pressure on both train and bus service. Competition, while good for consumers, is uncomfortable for many decisionmakers in the airline industry who would like to see regulation reimposed.
One lesson is to be wary of advocates of regulation who try to persuade legislators that certain laws or rules are in the public interest. Self-interest is a strong incentive to develop arguments that may bamboozle the general public. Although many government activities do serve the public interest, the specifics of many of the government policies are similarly shaped by special-interest groups.