TIRED OF DUMB REGULATIONS? HERE'S THE FIX

For decades, small businesses have been constrained by outdated, obtuse, and overwhelming bureaucracy. Inc. proposes a smarter regulatory system in which entrepreneurs can thrive

ONE WHOLE DAY every month, Brian Leventhal, CEO of Brooklyn Winery, sits in his office filling out forms and writing checks. To Virginia: $4. To Illinois: $2.78. Each state has different requirements. New Jersey, one of the neediest, demands detailed information on every shipment made to one of its residents. “I am writing that this person bought four-tenths of a gallon of wine,” says Leventhal. “I am writing their address. I am writing their name.”

That is hardly the best use of time for the leader of a $5 million, 40- employee business. But Leventhal has no choice. “It’s so complicated that I’m the only person who understands it,” he says. “Even if you get zero sales, you still have to send your slip in saying you did zero sales or you start getting threatening letters back from the states.”

Philip K. Howard is sitting across a conference room table listening to Leventhal with sympathy, disgust, and a certain perverse glee. Howard is founder of Common Good, a nonprofit that uses research and advocacy to promote ideas aimed at whittling away bureaucracy with the blade of common sense. He’s spent the past 20 years dedicated to this cause— writing four books examining the inanities of the legal system, while attracting former presidential candidates from both sides of the aisle to Common Good’s advisory board.

On this particular day in March, Howard has invited some entrepreneurs from the Inc. 5000— our annual ranking of America’s fastest-growing private companies—to his midtown Manhattan office to share their experiences coping with regulation. Leventhal is especially vocal. His company spends a lot of money buying grapes from Sonoma and Napa, California, and he wants to trumpet that fact. But, as he explains, the U.S. Alcohol and Tobacco Tax and Trade Bureau requires vintners that obtain grapes from “noncontiguous” states and include that information on their labels “to limit sales of wine produced with those grapes to the state in which that wine is produced”—in his case, New York. This rule exists, suggests Howard, to protect vested interests. But, he adds, “it looks like [rules governing the wine industry] exist only because someone made them up that way 80 years ago.”

That could be said of tens of thousands of governmental rules that appear arbitrary, irrational, or outdated. Unfortunately, the list is only growing. Roughly 3,400 federal regula- tions were issued in 2015, 545 of which directly affect small business, according to the Competitive Enterprise Institute. The Office of Management and Budget reports that another 3,000 are on course for this year. Entrepreneurs are, or soon could be, grappling with new federal and state rules related to—among other things— overtime, sick leave, health care

reporting, employee retirement plans, independent contractors, lead dust in commercial buildings, and website accessibility for the disabled. The most recent academic paper on the topic released by the Small Business Administration’s Office of Public Advocacy—in 2010—reports that per-employee regulatory costs for small companies are 36 percent higher than those for large ones.

Meanwhile, state and local regulations proliferate like kudzu. (Notably, the USDA has declined to classify kudzu as a noxious weed in need of interstate control.) As companies increasingly operate in multiple markets, conflicting rules complicate matters further. Vermont requires the labeling of foods made with genetically modified organisms. Tompkins County, in New York State, recently put the kibosh on health and beauty products containing microbeads. In Indiana, liquor stores can sell soda and water that is warm but not cold.

Entrepreneurs understandably feel snarled in red tape. According to the HR services company Paychex, in a survey of more than 400 small-business owners conducted for Inc., 65 percent reported that regulations had hurt profitability or their opportunities to grow.

Most entrepreneurs we know want to do the right thing for their employees, their customers, and the environment. They don’t chafe against regulations, which exist chiefly to reduce public risk. The problem is that most regulations take into account only the downsides and not the upsides of risk. Every time your business is prevented from doing something or you choose not to do something because the government makes it difficult, there is an opportunity cost. According to the Paychex survey, concern over regulation had dissuaded 39 percent of respondents from entering a new market, 36 percent from introducing a new product, and 25 percent from starting a particular kind of business.

We want to flip that equation, allowing regulation to do its job, but not at the expense of small businesses’ growing and innovating. Inc. has compiled some of the most promising ideas gaining traction with both government and its critics for building a smarter, less restrictive regulatory system.

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GIVE STARTUPS BREATHING ROOM

New companies are most vulnerable in their first five years, a stage when distractions can be fatal. John Dearie, co-author of Where the Jobs Are: Entrepreneurship and the Soul of the American Economy, says a temporary exemption from nonvital

We want to flip that equation, allowing regulation to do its job, but not at the expense of growth and innovation.

regulations could make all the difference.

Dearie proposes “a stripped- down starter framework,” for new businesses, co- developed by the Office of Budget and Management and the Congressional Budget Office. Under the framework, startups would have to conform to labor, safety, and environmental rules necessary to protect the public, but on everything else, they’d get a five-year pass. The specifics would change over time in sync with changes to other regulations, for example, those setting a national minimum wage.

“If you launched in 2015, the regulatory framework would be applied to you through 2020, so you wouldn’t have to deal with the uncertainty of new regulations coming at you all the time,” says Dearie. After five years, the framework would be lifted. Then, he says, “you are thrown in, sink or swim.”

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TREAT DISRUPTERS DIFFERENTLY

When change threatens to topple industries, the first thing entrenched companies do “is run to their regulators and say, ‘You have to stop this. You have to make these startups play by the same rules we played by,’ ” says Larry Downes, a project director at Georgetown University and co-author of Big Bang Disruption: Strategy in the Age of Devastating Innovation. “They want all those old rules applied regardless of whether they’re a good fit or a bad fit. And often, they’re a very bad fit.”

Regulators typically subject disruptive startups to “the entire canon of existing regulations,” says Downes, “and then work backward, eventually, to figure out which ones to remove.” So in regulators’ eyes, Airbnb guest rooms become hotels, genetic testing services become drug companies, and crowdsourcing platforms become stock exchanges.

Instead, regulators need to acknowledge when they have a disrupter on their hands. Downes says that, while there is no concrete mechanism to formally label an upstart, the signifiers are pretty clear. If a startup competes with traditional, regulated companies for customers, but does so in a different way—almost always using technology—regulators can assume it’s disruptive.

Then, the government should enforce only those regulations necessary to protect consumers, ensure public safety, reduce pricing abuses, and promote competition. Sure, disrupters will experience unanticipated problems, but technological change and the markets will address those faster than government ever could. “That,” says Downes, “is how you start to get an innovation agenda.”

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APPLY PRINCIPLES RATHER THAN SPECS

Common Good’s Howard likes to tell the story of the New York City restaurant owner who was fined because the cheese slices next to his griddle were 45 degrees, instead of 41 degrees as required by code. Those additional four degrees presented no health threat—not to mention, the cheese soon would be bubbling at a much higher temp on a beef patty. But that’s what many codes and regulations do: provide voluminous and excruciatingly precise requirements that reduce inspectors and other officials to mindless measurers and box checkers. Those specifications may be hard and costly for small businesses to meet, while not appreciably protecting the public good.

Which is why Howard believes rules that don’t logically demand precise technical requirements—in contrast to, say, most environmental regulations—should be framed as broad principles or goals rather than as rigid rules. He gives the example of nursing homes, which are “typically regulated with about a thousand rules that say you must have .09 recreational workers per resident, and food must be stored not less than 15 centimeters above the floor.” He holds up as an alternative changes made to Australia’s nursing home rules, which were simplified to a series of general principles, such as “have a homelike setting” and “serve nutritious meals.” Professors at Australian National University studied the impact of that model, says Howard, discovering that while “people originally scoffed that nursing homes would get away with murder, within a year they were twice as good”—and even outperformed U.S. institutions. The reason: Operators no longer drowning in minutiae could focus on big-picture issues that affected their customers.

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CLEAR OUT THE DEADWOOD

Regulations are like plastic bags and embarrassing social media posts: Once they’re out there, you can’t get rid

of them. “Over the years, there has been an accumulation of regulations, all of them for good reason, but kind of building up,” says Michael Mandel, chief economic strategist at the center-left Progressive Policy Institute. “And there isn’t any good mechanism in the federal government for undoing or pulling back regulations that either have outlived their usefulness or cumulatively weigh on innovation and small businesses.”

Some politicians advocate for sunset clauses on new regulations, but to thin the existing crop, you need a technocratic solution. Mandel and his colleagues have proposed the creation of an independent advisory committee— similar to military-base- closure committees—that would evaluate sets of 15 or 20 older regulations at a time, make recommendations for their elimination or modification, and then submit the whole bundle for an up- or- down vote by Congress. “If you look at these regulations one at a time, opponents would rise up to stop action on that particular one,” says Mandel. “By putting it in a package, you make it easier for members to vote in favor, even if there is a piece within it they don’t like.”

Certain categories of rules—for example, those governing the environment and occupational safety— could be off the table, in order to build public trust. Bills based on Mandel’s recommendations are currently pending in the House of Representatives and the Senate.

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MAKE GOVERNMENT ACCOUNTABLE FOR FAILURE

“America is run by dead people,” says Howard. “The people who wrote those rules are dead, so you can’t argue with them or hold them accountable.” Some regulations date back 60 years, so it is vital that live human beings have the power to interpret them, says Howard. In general, those who enforce the rules should be encouraged to exercise their best judgment depending on the situation. All too often, regulators and inspectors are conditioned to say no, because that’s the safe bet.

Common Good’s proposed solution: Reengineer the civil service profession to treat regulators more like employees in the private sector. Reward initiative and problem solving rather than mindless enforcement of every letter of the law. Officials would have more time to detect genuine threats while giving entrepreneurs the room to do their jobs intelligently. “You have a civil service system now where people are only accountable, if at all, for mistakes,” says Howard. “We need one where they are accountable for the absence of success.”