Regulatory Climate Index 2014: Section I
The United States has evolved into a predominantly urban society with more than 80% of the population putting their roots down in cities, weaving a diverse and vibrant social fabric where these citizens live, work, create, and connect. The nearly $16 trillion American economy comprises hundreds of diverse urban economies, from Boston to Dallas and Raleigh to San Francisco, serving as a key fuel for growth and prosperity. Community is a form of currency in the global marketplace, and cities matter more than ever.
The dynamism of the urban America economy rests particularly on the innovation, hard work, and ingenuity of its small businesses and entrepreneurs. Small firms and start-ups are essential in creating new employment opportunities and generating new economic activities. Indeed, nearly all of net job creation in the United States occurs in firms that are less than five years old. Further, small firms accounted for 64% of net new jobs between 1993 and 2010, and employed nearly half of all private-sector employees across the U.S. economy. New companies and their entrepreneurs constitute the main engine for job creation and economic growth. There are strong linkages between start-ups and cities.
Policymakers at all levels make decisions that have significant implications for business. Regulations and rules place a disproportionate burden on small businesses due to the margins of capital to run a small firm. The U.S. Small Business Adminis- tration estimated that small businesses have been burdened with $1.75 trillion total cost of compliance for federal regulations. Many of these costs do not vary by firm size and are incurred on an ongoing (rather than one-time) basis.
Yet few city-level studies have explored the regulations that strengthen businesses as well as those that restrain them. This study is meant to be a needed corrective, adding to the critical bank of knowledge that business and policymakers alike draw on when aiming to enhance economic growth. The Regulatory Climate Index is a barometer of business friendliness and a proxy for a city’s competitiveness.
Importance of Cities to Economic Growth
With their ample capital and diverse economies, cities are a fertile ground for starting businesses. Indeed, they are ideally suited for attracting the diverse labor skills, materials, and processes that are required to develop entrepreneurial small firms. Cities have served as America’s economic driver since at least the mid-20th century.
The growth and vibrancy of America’s cities is intrinsically tied to the performance of small businesses and entrepreneurs. This is a central reason for this Index’s focus on small businesses. Estimates show a 10% increase in the number of firms per worker at the city level correlated with a 9% increase in employment growth. Another study found that local competition and urban variety encouraged employment growth across industries in 170 U.S. cities over a more than 30-year period.
Urban economies and entrepreneurship work in unison. Knowledge and ingenuity thrives in dense spaces, spilling over into other areas where, together, they serve as dynamic engines of growth. These local externalities encourage what is known as the spatial agglomeration of firms and employment in a way that favors localized growth. Simply put, firms benefit when they are located near one another.
Evidence overwhelmingly shows that economic growth and job creation are highly correlated to entrepreneurship in start-up companies. The economic diversity of cities, varying institutional factors such as taxes and regulations, and competition for business operational locations have naturally led to assessing urban economies on factors of economic performance, business climate, and overall business friendliness.
Cities thrive on innovation, expansion of small businesses, and entrepreneurship. Growth, new business formation, and free enterprise will do more for a city’s economy than any economic development policy can induce on its own. Economic achievement is tied to a fair and transparent legal infrastructure. The successes and failures of cities, small businesses, and entrepreneurs will depend heavily on rules and institutions that enable advancement and future prosperity.
Impacts of Regulations on Businesses
Regulation takes places at all levels of government—federal, state, county, and municipal—through laws and ordinances across industries. The practice is also common through industry organizations that set standards and professional orga- nizations that handle accreditation of their members. Classical economic theory defines regulation as an intervention to correct market failure, limit market options for monopolies, provide public goods, ensure adequate information in the market, and eliminate undesirable externalities.
Despite the United States’ prosperity, poorly designed regulations can and have become obstacles to doing business there. Smart regulations are a necessity for facilitating economic activity and enabling fair business operations. All economies have rules and institutions that govern the behavior of their actors. Regulation should be simple, expedient—both in implementation and execution—and unambiguous, minimizing the uncertainty that firms face when entering the marketplace.
Regulations have an impact on firms, firm behavior, and overall economic growth on the macroeconomic level. Entrepreneurs and small businesses entering the market face the “compliance burden” through complicated, redundant procedures and inconsistent, high costs for entering the marketplace. Artificial entry costs deter entrepreneurship at the margin; thus, reform, through the reduction of entry costs, is predicted to affect entrepreneurship and job formation positively. Evidence shows that entrepreneurship is higher when fixed costs (e.g., entering the marketplace) are lower. Further, the impact of regulation on business entry signifies that such regulations and costs are associated with reduced job creation and reduced entry of new firms.
U.S. Chamber of Commerce Foundation's Regulatory Climate Index
We know the economic contributions of small businesses and entrepreneurs to the U.S. economy and the importance of cities to economic growth. We have seen studies and indexes measuring the business climate and competitiveness of national, state, and urban economies; however, little research and empirical data measuring entry regulations and costs of doing business for entrepreneurs and small businesses across U.S. cities exist.
A comprehensive survey of current state business climates found the rankings often vary wildly, depending on the focus of the indexes.13 For example, indexes focused on productivity do not predict economic growth, whereas indexes emphasizing taxes and costs predict growth of employment, wages, and output. The Regulatory Climate Index fills the gap by assessing and comparing the complexity and regulatory burden of 5 areas across 10 U.S. cities.
The U.S. Chamber of Commerce Foundation’s 2014 Regulatory Climate Index adopts the analytical framework that was jointly developed by the World Bank and the International Finance Corporation (hereafter referred to simply as the World Bank) to measure the impact of regulation on a small, local business. The World Bank uses a unique framework to compare the regulatory burden of doing business across 189 countries in its Doing Business 2014 report and across cities within various countries (in their subnational reports).14 In its global reports, the World Bank includes 10 areas of regulation to compare across countries. National regulations that are mandatory for all businesses across cities within a country are omitted in its subnational reports. For example, Doing Business in Italy 2013 compared 5 areas of regulations (Starting
a Business, Dealing with Construction Permits, Registering Property, Paying Taxes, and Enforcing Contracts) in 13 cities and 7 ports in Italy. Similarly, Doing Business in Mexico 2012 compared 4 areas of regulations (Starting a Business, Dealing with Construction Permits, Registering Property, and Enforcing Contracts) across 31 Mexican states and Mexico City.
The Regulatory Climate Index assesses 5 areas of regulation across 10 cities in the United States. These five areas of regulation represent the life cycle of a business: Starting a Business, Dealing with Construction Permits, Registering Property, Paying Taxes, and Enforcing Contracts. We also follow the World Bank Doing Business framework to define three factors to measure the regulatory burden—the number of procedures, time to comply with the requirement, and the costs and fees paid to the government or service providers that are required by the local laws. The Regulatory Climate Index’s scores and ranks are the simple average of ranking of all five areas of business regulation in each city. Each of the five areas of business regulation is again the simple average of the normalized values of procedures, time, and costs. Each component in an area of business regulation is ranked relative to the other nine cities.
The Regulatory Climate Index applies U.S. Small Business Administration (SBA) classifications and data published by the U.S. Census Bureau to select criteria, such as annual revenues and number of employees for a representative firm.15 The Regulatory Climate Index also relies on actual values of other measures, such as revenues per employee, construction costs, and property prices that are publicly available to define the benchmark for the representative firm. Table 1 summarizes five areas of business regulation, assumptions, and weights to construct the Regulatory Climate Index. A full, detailed discussion of the technical framework and the construction of the Index is provided in Section III of this report.
This first release of the Regulatory Climate Index assesses 10 cities across the United States. These places are selected to represent a wide range of economic and demo- graphic backgrounds of small and large cities across all regions. The focus remains on the city rather than on the disparate metropolitan area. The size of population ranges from 318,069 people in St. Louis to more than 8.2 million people in New York City. Annual income per capita is as high as $46,777 in San Francisco and as low as $15,261 in Detroit. The number of businesses varies from 23,637 entities in St. Louis to 944,129 entities in New York City (Table 2).
Regulatory Climate Index Ranking
The Regulatory Climate Index is compiled from official data on regulatory procedures, time, and costs that applies to small businesses. This desk research uses publicly available information from official sources, including the secretary of state, economic development offices, departments of taxation and finance, departments of labor, municipal codes, and local courts. The Regulatory Climate Index is then reviewed by local experts—including attorneys, accountants, trade associations, and chambers of commerce.
The Regulatory Climate Index ranks the overall scores of the cities from 1 to 10, where 1 represents the city with the most efficient regulatory environment for small businesses and entrepreneurs. These findings are the average ranking of all five areas of business regulation in each city. Scores in each of the five areas of business regulation are, again, the average of the normalized values of procedures, time, and costs.
All cities provide small businesses with basic information to comply with the five areas of business regulation that this Index measures. Yet the websites and publications are often disorganized, missing information, or unclear to an outsider, likely creating significant confusion for a small business owner. Few cities provide detailed information on the procedures, expected waiting time, and administrative costs for construction permits. Overall, no city provided comprehensive information for each of the business regulation areas. The impact on business is particularly felt in the time wasted. Business will likely need to rely on an outside expert to navigate the local rules and regulations—often at great expense. Though these factors are not included in the Regulatory Climate Index, as they are unique to each business’ circumstance, they are nonetheless all too real.
Among these 10 cities, Dallas and St. Louis impose the lightest regulatory burden on small businesses. Raleigh, Boston, Atlanta, and Detroit have moderate overall scores. New York City, San Francisco, Los Angeles, and Chicago, on the other hand, are marked by high regulatory requirements to open and operate small businesses (Table 3).
The basic regulatory steps for opening and operating a business remain relatively similar across the U.S. cities measured. Indeed, many cities have improved proce- dures and standards over decades while striving for greater efficiency. Nevertheless, there are sizable variations in the design, practice, and costs to fulfill a standard regulatory requirement.
The Regulatory Climate Index shows that a city often performs well in one area and has room for improvement in another. For instance, while Dallas outperforms other cities when it comes to Paying Taxes and Registering Property, the process of En- forcing Contracts in Dallas lags behind other cities in the Index. The costs to Register Property in New York City are far more expensive than in other cities, yet Dealing with Construction Permits there is less burdensome than many of its peers in this report. San Francisco and Los Angeles, in contrast, have the most efficient process to open a professional service business (Table 4). Geographical and historical influences also play a role in the design of city-level business regulations.
2014 Regulatory Climate Index - Areas of Business Regulation
This section provides overall observations and analysis across the five areas of business regulation measured in this Index. More detailed analysis of each city’s performance, along with information about programs to support entrepreneurs and small businesses, is provided in Section II.
The overall score for the cities in the Regulatory Climate Index are built on five areas of business regulation measured by three factors—the number of procedures, the number of days for completion of the requirements, and total costs required by the law. The score of each area of business regulation is a simple average of these factors.
The cumulative ranking, of course, does not tell the complete story of the local business environment, let alone the entire regulatory apparatus. Rather, it serves as a barometer for what a small business, in particular, can expect when launching and operating in some of America’s leading cities.
In the past few years, several cities in this report have worked to make substantial improvements in the way that businesses interact with local regulations. These places have also invested significant time and energy in improving the overall potential of their local economies. These efforts are manifested in local networking events, start-up incubators, programs that enable greater access to capital, and the elimination of certain unnecessary local regulations.
Starting a Business
In general, creating a formal business entity to provide professional services—the hypothetical case considered in the Index—is relatively simple and inexpensive. It could take as few as four procedures and $70 to start a business in Los Angeles, for instance. In most cities, a business can be operating in less than a week. As a reminder, these figures should serve as a hypothetical baseline by which we can compare each city; the regulatory burden will shift or grow based on the circumstances of each business. Nevertheless, the number of procedures, waiting time, and costs for administrative compliance do not vary significantly across eight of the cities here (Table 5).
wo cities have additional requirements that are unique to them: for example, New York City requires the business owner to publish the intention of opening the business in two local newspapers for six consecutive weeks. The cost to open a professional service LLC in New York City ($1,306) is more than 18 times higher than in the 2 lowest cities of Los Angeles and San Francisco ($70). In Chicago, an entrepreneur who wants to open a professional services LLC must wait an additional 25 days for a professional service license through the mail before the business can begin operating the services. The required time to open a professional service LLC in Chicago is more than 6 times longer than that most of other cities—32 days compared with 5 days.
Dealing with Construction Permits
Obtaining construction permits varies substantially across cities in terms of costs, time, and required procedures. Most of these differences stem from the zoning approval process, environmental reviews, and building permit reviews. The regulatory costs run an average of 1% of the construction costs and 3 months of processing
in order to complete a set of 15 standard procedures. This process includes both pre- and post-construction phases for small commercial buildings.
Obtaining information and understanding regulatory requirements can be burden- some across cities. Costs of construction permits also vary substantially. Dallas, Raleigh, and St. Louis have the lowest fees for administrative compliance, ranging from 0.3% to 0.7% of the total cost of construction. Atlanta, Boston, Chicago, Detroit, and New York City have moderate costs of permits, ranging from 0.8% to 1.3% of total construction costs. Los Angeles and San Francisco have the highest costs of permits at more than 3.0% of total construction costs—a not unsubstantial sum (Table 6).
The costs to obtain construction permits in San Francisco and Los Angeles are about 10 times the permit costs in Dallas and Raleigh. Waiting times are as low as two months in Raleigh, Dallas, and St. Louis, while at least twice that in Chicago, Los Angeles, and San Francisco. These costs are largely driven by additional procedures required by those cities. For example, San Francisco obliges builders to submit a city environmental quality review that would cost an extra $50,000 in fees (the equivalent of 1.6% of the construction costs) to the city and takes (at least) an extra 66 days to review. Los Angeles has a similar procedure, but with a lower cost. Atlanta, Dallas, and Raleigh offer expedited and streamlined services for construction firms when applying for permits. They also provide express services for inspection, which improve the pace to grant occupancy. These actions eliminate unnecessary procedures, accelerate the approval of permits, and decrease the waiting time for construction firms and business owners.
Across the 10 cities, the procedures and time for administrative compliance do not vary significantly. Completing the administrative requirements for Registering Property in the sale of a commercial building ranges from four to seven standard procedures and between 0.5% and 1.0% of the transaction cost to transfer and record the title. Again, these are baseline scenarios represented in the Index, and they may vary greatly, depending on the particular case. Real estate transfer taxes and other fees increase the costs of commercial building transactions and vary across cities. Our numbers do not factor in closing time or fees in the calculations of the regulatory costs because they are not directly determined by the regulations; instead, they are caused by other factors and private vendors (Table 7).
Dallas and St. Louis do not have real estate transfer taxes, while Atlanta and Raleigh have low real estate transfer taxes. Boston, Chicago, Detroit, Los Angeles, New York City, and San Francisco all have higher real estate transfer taxes. New York City has two additional administrative costs—a mortgage recordation fee of 1.925% and real property transfer tax of 2.625% that impose significant costs in commercial real estate transactions.
The number of payments and amounts of tax vary across cities, based on state and local tax rates, including corporate, employment, and sales taxes. Cities also impose local taxes, such as business license taxes, that increase the overall cost of doing business. Dallas is the best-performing city because there is no state or local corporate tax. Atlanta, Detroit, and Raleigh are the next crop of cities to provide a tax environment that favors entrepreneurs. Chicago, Los Angeles, and San Francisco rank near the bottom due to a higher tax burden (Table 8).
Corporate income tax rates vary across city and states. Dallas and the state of Texas have no corporate income tax. Atlanta, Detroit, St. Louis, and Raleigh have moderate corporate tax rates, ranging from 6% to 6.25%. Boston, Chicago, Los Angeles, New York City, and San Francisco have the highest tax rates in the range of 7.1% to 9.5%. Unemployment taxes also vary across cities and states. Atlanta, Dallas, Detroit, and Raleigh have the lowest employment taxes, ranging from 1% to 2.7%. Boston, Los Angeles, San Francisco, and St. Louis have moderate rates, ranging from 2.71% to 3.51%. The highest rates vary from 4.1% in New York City to 4.15% in Chicago.
In addition to corporate and unemployment taxes, small businesses must pay sales taxes on their purchases as well as license and professional fees. The overall sales tax burden across the 10 cities ranges between 6.0% and 9.25% of total operating expenses. Three cities facing high sales tax burdens are Chicago, Los Angeles, and New York City; the three lowest sales tax burdens are found in Detroit, Boston, and Raleigh.
Some cities bear unique tax burdens. While most cities require a business license tax, Los Angeles imposes an onerous 5.07% business license tax on gross receipts for professional services companies. Businesses in Los Angeles and San Francisco also have to pay 1% of state disability insurance (capped at $1,008.80) per employee per year. Chicago requires businesses to pay $2 per month per employee for the state employee expense tax.
Efficiency in the local court system is crucial to ensure that business agreements are protected under the law. Although relatively insignificant in the overall expense of litigation, the time and costs required by courts provide an indicator of what it takes to maintain and protect each city’s business environment. Overall, there are not significant variations in the number of procedures and administrative costs; however, there are significant differences in the waiting time for steps within the process (Table 9).
The number of procedures and administrative costs for enforcing a contractual arrangement in a city are relatively uniform. The major variations come from the total waiting time for steps in the administrative process. Chicago, Dallas, and Atlanta have low waiting times compared with Detroit, Boston, and New York City, where a business could expect to wait more than a year to settle a dispute.
This project analyzes and measures the regulatory environment by evaluating the procedures, time, and costs required for starting and operating a business across 10 U.S. cities. There are no clear-cut winners and losers. Rather, each city performs well in certain areas and needs improvement in others. The ultimate goal of this research is to encourage cities to improve their regulatory environments in support of their local entrepreneurs.
Cities are home to more than 80% of America’s population—no wonder they are critical engines of America’s economic growth. Entrepreneurs come to cities with business ideas and are willing to take risks to make these ideas a reality. Regulations are necessary, but poorly written rules, costly procedures, and burdensome processes hinder the growth of small- and medium-sized enterprises and hurt competition
in domestic and global markets. Improving the quality of institutions that influence entrepreneurs will help determine the economic future for urban economies.
Local officials and policymakers can better understand the business conditions facing entrepreneurs and small firms by simply looking at the local laws, processes, and costs on the books for starting a business and other regulations common over the life cycle of a business. The success of their cities depends on improving existing regulatory processes, simplifying the business licensing procedures, and easing the barriers to entry for entrepreneurs who can further unleash the promise of free enterprise for American cities.