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An Even Larger Headache Than Taxes for Small Businesses

Jared Meyer | 06/13/2014 |
Free Press/CC

What is the biggest challenge faced by small businesses today? Surprisingly the answer is not high taxes—it is professional licensing requirements.  

Thumbtack, a business services firm, in partnership with the Ewing Marion Kauffman Foundation, just released its third annual Small Business Friendliness Survey. This comprehensive survey collects data from nearly 13,000 diverse small business owners to evaluate how business climates differ across the nation. Doing so provides a clearer picture of how policies affect entrepreneurs than does only analyzing government data. 

Licenses, requirements that individuals gain government permission to work, raise the barriers to entry in an industry, in terms of both time commitment and cost. Barriers to entry also allow those who already have established businesses or can afford to comply with onerous regulations to charge higher prices, hurting consumers. 

Entrepreneurs are focused on bringing their ideas and skills to market, and want to use all their available, and often limited, resources to do so. Seeking government approval to go into business is a waste of their valuable time and money. This is why the friendliness of professional licensing regulations was found to be the only statistically significant non-demographic variable for predicting states' business environments. 

Only 35 percent of Thumbtack's respondents thought they paid too much in taxes, showing that respondents did not use the survey to complain about every difficulty they face. Many small business owners saw professional licenses as their largest problem because these requirements have moved far beyond their justification of protecting public safety. Through sheer accumulation and the influence of special interests, they now impede progress—to the detriment of the public's well-being. 

Half of Thumbtack's respondents reported being subject to at least one professional licensing requirement. This is not surprising. University of Minnesota economist Morris Kleiner and Princeton University economist Alan Krueger found that nearly four out of every ten U.S. workers will require government certification or licensing to work in their desired occupations. In the early 1950s, less than 5 percent of the workforce needed a license to work. 

Excessive permitting processes are part of professional licensing. They also act as a deterrent to work and were seen as a large problem by small businesses. The utter complexity of many states' permitting processes makes it difficult for entrepreneurs to focus on getting their ideas off the ground, and for small business owners to devote the necessary time to ensuring their businesses stay alive. 

Business environments differ substantially across the United States. Utah, Idaho, Kansas, Virginia, and Texas received the five highest ratings for having small business-friendly professional licensing requirements. Rhode Island, Connecticut, Illinois, Massachusetts, and California received the worst ratings. It is no surprise that the average real GDP growth rate in 2013 was twice as high in the top five states compared to the bottom five (2.72 percent and 1.36 percent).  

Thumbtack's findings do not stand alone. John Dearie and Courtney Geduldig, in their book Where the Jobs Are, describe what they learned from holding 12 roundtables and countless meetings with entrepreneurs throughout the country. 

Alan Blake, of Austin, Texas-based Yorktown Technologies, told Dearie and Geduldig, "Small businesses in particular struggle with the complexity and risk associated with employment-related regulations. The result is that many companies are much more reluctant to hire than they would be otherwise." Since new businesses create about three million jobs a year, and account for practically all net new job creation, policies which make it harder for entrepreneurs to get their businesses off the ground are especially destructive. 

When small businesses are able to prosper, the economy grows. In the service industry, 81 percent of businesses have no other employees besides the owner. As the Thumbtack report states, "Over 99 percent of U.S. employer firms meet the Small Business Administration's definition of small businesses, and they account for nearly half of all private sector employees. Over the past two decades, almost two-thirds of net new private sector jobs have come from these small businesses."

If barriers to work were pared back at all levels of government, more people would pursue starting their own businesses instead of dropping out the of the labor force. Often, unexpected layoffs or career setbacks are the sparks entrepreneurs need to begin working for themselves or take chances on new businesses. With the labor force participation rate falling to 1978 levels, policies should make entering and remaining in the workforce easier, not more difficult. 

While tax burdens and complexity rightly receive much attention, professional licenses are often ignored. This is one reason occupational licenses and permitting requirements continue to grow in number and scope. As Thumbtack's survey shows, small businesses owners know what stands in the way of success. The economy would grow much faster if professional licenses were reformed.

 

Jared Meyer is a policy analyst at Economics21 at the Manhattan Institute for Policy Research. You can follow him on Twitter here.

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