Compliance inflation is crushing small businesses

The U.S. is known for being an incredible place to start a business. Every day, entrepreneurs create jobs, contribute to their communities, and foster innovation. And they’re not slowing down. In 2023, we hit a 20-year record for the most new businesses formed, despite rising economic inflation.

But there’s another type of inflation that’s less visible, yet unnecessarily damaging: compliance inflation. Small businesses need to navigate a vast, complicated, and ever-growing web of regulations and requirements. Every year, a staggering 15,000 new laws get passed at all levels of government, according to the U.S. Chamber of Commerce. Yet old ones rarely get removed.

I speak with small business owners across the nation regularly. Across the board, dentists, flower shops, tech startups, and restaurants, all want to be compliant with rules and regulations—but it gets overwhelming, time-consuming, and expensive. The U.S. Chamber of Commerce found on average, small businesses spend 200 hours and $11,700 per employee per year on compliance. That doesn’t even include financial penalties.

It shouldn’t be this way. Policymakers have a huge role to play in controlling compliance inflation.

This is one of the most urgent economic issues we face today. Small businesses are the bedrock of our economy, making up 99.9% of all U.S. firms and driving innovation. They need policymakers to lighten the load.

Here are some ways policymakers can help tame compliance inflation and better support entrepreneurship.

Simplify outdated requirements

We need policymakers to commit to timelines to review and update outdated requirements—and where possible, use tech to make compliance easier.

For example, some states still require “wet” signatures on paper documents. Other states enforce outdated laws where notaries must witness authorization form signatures, in person. This is antiquated and time-consuming when electronic signatures have been widely accepted for years.

Another example: To help small business customers stay compliant with the IRS, payroll providers collect their Employer Identification Numbers (EIN)–—the primary business identifier when filing tax forms. But sometimes the business makes typos, accidentally typing in the wrong number.

Unfortunately, if the customer makes a typo, payroll providers aren’t notified by the IRS right away. Several months later, the IRS will send a CD-ROM—yes, you read that correctly—that needs to be manually installed for review.

With this outdated, slow process, the IRS makes it hard for payroll providers to quickly verify EINs and to correct previous filings on small business’s behalf. The longer the delay, the greater the financial penalties for small businesses, all stemming from simple human mistakes.

To help solve these issues, we regularly consult with policymakers, while monitoring and responding to upcoming changes impacting small businesses. We’re encouraging the IRS to adopt APIs to avoid these types of common errors. We’re also staying ahead of new regulations like the Beneficial Ownership Information Reporting Requirement by building tools to help businesses comply.

Ultimately, policymakers need to update their requirements and processes to keep up with current technology, so small businesses aren’t punished for simple mistakes.

Design new regulations with small businesses in mind

One principle at Gusto is the OODA loop: observe, orient, design, and act. It’s an iterative design approach basing product and operational decisions on what we’ve learned from our customers. For policymakers, this approach can be highly effective when treating small businesses as their “end users.”

For example, to pay employees, small businesses have to register with the IRS and then register separately with multiple tax agencies in the same state—which all use different processes. A single registration process would be much simpler.

Many businesses rely on payroll providers like Gusto to handle registration and payroll tax filings (and we happily do all this work for them behind the scenes). But they still need to authorize their payroll provider with the IRS, and then again separately with each tax collector. In fact, Washington state employers have to do authorizations with four different tax collectors. It’s easy to imagine how complicated this gets for employers hiring remote workers in other states.

These are incredibly siloed, redundant processes adding to small business’s compliance burdens. We’re encouraging state agencies to develop simpler processes, while we build new state tax registration systems to automate where possible.

But at the end of the day, policymakers need to consult with small business groups and get early feedback, so they can create simpler processes and ultimately increase compliance. That’s a win for everybody.

California’s state retirement mandate is a great success story for this approach. Ahead of compliance deadlines, the agency behind the mandate went on a state tour to get feedback from small business councils and agricultural groups. This led to a major boost in California employers offering retirement plans to their employees. In fact, at Gusto, we saw a 35% increase in 401(k) plan adoption.

Explore models to support small business compliance

Finally, policymakers should consider other models for driving compliance, like being positive rather than punitive.

In 2020, Minneapolis launched a new paid leave program for lower-income workers. Once the deadline passed, they saw many businesses were out of compliance. Instead of penalizing or fining them, Minneapolis’s city council launched a pilot program for payroll and bookkeeping services.

There are positive lessons here for other policymakers. Models like these provide underserved, under-resourced businesses with the education they need for compliance.

When it comes to compliance inflation, we’re now at an inflection point. Policymakers have a choice going forward—they can make things simpler or make them harder. We hope policymakers will take the right steps to help more small businesses succeed. The future of our entrepreneurial ecosystem depends on it.

Tomer London is cofounder and chief product officer of Gusto.