“We got the business phone put in and I gotta run by Insty-Print to pick up my business cards,” Smitty said. “My wife is working with her uncle at XYZ Insurance to get the workers’ comp policy and our bond. I drove around last week and dropped off some fliers she made up at most of the general contractors in town. We’re almost set to go.”
Now Smitty (not his real nickname) was one of the nicest guys I ever had the pleasure to serve with in two decades in the Army Reserves. He was also one of the dumbest. One time the NCO who was his immediate supervisor said to me, “You know, some days Smitty can make a box of rocks look absolutely brilliant.” Smitty didn’t complete any formal education after the ninth grade and I am sure that the first few years he laid block, his foreman had to keep reminding him which side of a block goes up.
But Smitty was smart enough to know that if you run a small business, you have to secure workers’ compensation coverage for your employees. And so when he took the big step of going into business for himself as a subcontractor, he followed the law.
This is something that escaped Minnesota’s new labor commissioner, Jane Volz, who went to school for at least 10 years longer than Smitty.
Now sometimes I do have a mean streak. When I picked myself up off the floor laughing after reading Volz’s “It-was-an-oversight” reason for not getting workers’ comp, I was tempted to phone her and ask the thing my first sergeant asked me on a couple of occasions: “Well, just how dumb are you, then?”
But while an attorney claiming ignorance of the law is always good for comic relief in a time of national tension, there is an economics lesson in our labor commissioner’s befuddlement.
The lesson: Taxes and business regulation impose economic costs that are greater than the direct cost of the taxes or rules. In this case, when Volz or Smitty started a business, they incurred indirect costs in the time and effort needed to comply with the rules.
This existence of such a “burden” does not mean that taxes or regulations should be abolished. They may well benefit society. But indirect costs need to be taken into account when new taxes or regulations are designed.
The Bush White House ignored this lesson when staffers drew up the president’s proposal for exempting some, but not all, corporate dividend income from double taxation. Republicans are supposed to be for simplification of the tax code, but the administration’s proposal would institute a set of disclosure and record-keeping requirements that would be historic in their complexity. I cannot think of any change in the federal tax code in the last 30 years that imposed as large or costly an administrative burden as this would.
Excessive administrative costs also are trouble for the tax-free economic development zones that Gov. Tim Pawlenty likes so much. Anytime someone draws an arbitrary line and says, “On this side of the line you don’t pay the following taxes but on that side you do,” they create huge incentives for bending the rules. Soon, businesses that really conduct their activities elsewhere open up storefront offices in the tax-free zones to reap some of the implicit subsidy of lower taxes.
Regulatory agencies then react by writing more complex rules to make sure that any businesses that benefit from the tax-free zone “really deserve to.” Businesses spend still more money on attorneys and CPAs to find loopholes in the new, more-comprehensive rules. Soon even legitimate businesses have to fill out reams of paperwork to validate their purity. The amount spent on accounts, lawyers, bookkeepers, etc. soon dwarfs any true economic development benefit.
This fudging of rules is familiar to people like me who grew up near a state border. When a commercial trucker back home lost a Minnesota license for speeding tickets, he’d cross the border to Flandreau or Garretson, S.D., rent a P.O. box, and take the test to get a South Dakota license. After picking up the license from the P.O. box, he might not visit the town again for three years.
A local paving contractor who was debarred from MnDOT projects for bid-rigging “sold” his trucks and equipment to his wife, who in turn rented a storefront in a small town just across the South Dakota line and opened her “new” paving business there. The trucks, repair shop, main offices and so forth stayed right in Minnesota where they had been for 50 years, and the “new,” now even minority-owned, company kept right on getting contracts.
We can chortle about the insurmountable hurdles the Volz law firm faced in getting workers’ comp for four employees, but the broader phenomenon of regulations creating unintended incentives for evasion is a real one.
And it is one that does not bode well for the Pawlenty administration’s pet project of tax-free zones.
One final note about Smitty: He knew he needed to get workers’ comp because he worked in an industry with high injury rates.
People who hang steel, lay block or shovel guts on a slaughterhouse floor are much more aware of the importance of workers’ comp coverage than white-collar workers whose idea of heavy lifting is a briefcase.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.