Vermont’s Regulatory Burden and the “Shadow Economy”

By Bruce Shields

An accidental result of Tropical Storm Irene has been a demonstration of how costly is Vermont’s normal way of doing business. Vermont officials have reported that the actual cost of repairs has been about half of what was estimated in the days immediately following the flooding. Three reasons have been suggested for the reduction: greater efficiency because roads were completely closed to traffic; relaxation of very rigid labor rules; and streamlining of environmental reviews. Because Vermont’s overall public infrastructure was estimated in 2010 by Beacon Hill Institute to be the weakest of 50 states, all methods to reduce the cost of infrastructure work would clearly allow a greatly improved quality of life in Vermont.

Excessive reviews and strict regulation impacts every feature of Vermont’s economy adversely, lowering the standard of living across the board. For example, a high minimum wage, and regulations discouraging employers of high school students. We also have a high proportion of youth in prison — is that connected? Federal and State reporting requirements for part time work, for Workers Compensation liabilities and opaque instructions on how to collect, report, and pay such taxes, all contribute to the growth of underground employment. Increasingly, a substantial fraction of Vermont persons of employable age receive some component of income from public assistance with eligibility conditioned upon reported income. Both employers and job-seekers have substantial incentives to go “off the book.”

Economist Hernando DeSoto reported in his study The Mystery of Capital several illustrations of how excess regulation impedes economic well-being. He compared the steps of opening a small tailor shop in Cuzco, Peru, to opening one in Brooklyn, NY. The Peruvian had to obtain a certificate as a Qualified Tailor, get clearance from other shops already doing business, obtain a Federal, State and City certificates as a registered business — and on for some 30 different permits . The process took some 4 years and would have stalled without bribes. In Brooklyn, the tailor needs one month’s rent for security deposit, a small fee to register a trade name with the Secretary of State, and a valid occupancy permit from the Fire Department. A Merchant Account from a credit card company took longer, but in all the expense was about two weeks and only a few hundred dollars up front. A tailor in Brooklyn earns approximately 100 times what a tailor in Cuzco does. Applying that insight to Haiti, DeSoto was able to demonstrate that Haiti is actively hostile to the formation of new businesses by requiring existing businesses in effect to be compensated up front for the nuisance of having a new competitor, and by establishing obstacles both to the hiring and the dismissal of employees. Haiti is the poorest nation in our hemisphere, but has the heaviest regulatory burden regarding employment. Regulations to protect incumbents uniformly harm poor people.

Following publication of DeSoto’s findings, the World Bank partnered with a number of academic Economics departments to issue (jointly with Oxford University Press) an annual review of every country in the world titled Doing Business, a study of regulation in 181 economies. These look in annual rotation at about 12 major areas including how to register as a business, open or close bank accounts, borrow money, enforce contracts, hire and dismiss employees, pay taxes, and close a business. Some of the findings are astonishing: in Haiti, a legal employee must receive 24 months compensation upon dismissal. In Russia, a security deposit equivalent to about 10% of the maximum net worth of a business must be placed in a non-interest bearing account with the government. The results of this kind of regulation is highly predictable: legal employees in Haiti work only for government units or for international corporations. Businesses in Russia do not close — they just stop doing anything. Vermont’s regulation of business is about average for the US, but overall the US economy has slowly been becoming both more highly regulated and more stagnant. Some observers arguing that Vermont regulation has become burdensome enough to shift substantial employment into the “shadow” or “underground” economy, where barters and cash payments are the norm. Obviously good numbers are hard to find. But as the underground economy grows, tax collections will suffer. Just as simplification improved Vermont’s recovery of infrastructure following Irene, simplification of business and employment rules might stimulate the overall economy very quickly.

Bruce Shields has retired from three professions; college English teacher, sawmiller and executive of the Vermont Forest Products Association, and operator of a farm supply store. In retirement, he works his woodlot and maple sugar place, sits on the boards of several statewide organizations related to natural resources, and serves as Lister in the town of Eden, VT.