The inspection and regulation of small businesses has reached crisis proportions, and the next government must provide a respite

In the midst of severe recession, one industry has been thriving. As small businesses struggle to survive the downturn, the army of bureaucrats and inspectors tasked with regulating their activities has arguably never had it so good.

The regulation industry has boomed under a government that has enthusiastically embraced state intervention and micro-management of the economy. But the cost has been very high, particularly for small businesses.

Smaller firms generally can’t afford to set up the compliance departments, install the dedicated software or employ the specialist consultants that enable large companies to deal more easily with regulation. The economies of scale simply aren’t there. To take one example, a recent IEA study, Taxation and Red Tape, found that the administrative costs of tax compliance bear approximately sixteen times more heavily on the smallest businesses than on the largest.

But political attitudes may be changing. There are almost five million small businesses in the UK, employing over ten million people. Clearly the main political parties cannot afford to alienate the small-business vote. The sector – known for its innovation and flexibility – is also crucial to a sustained economic recovery. And given the size of the budget deficit, tax cuts may be impractical in the short term, making deregulation particularly appealing as a way of lowering business costs and encouraging growth.

Accordingly, all three main political parties are campaigning on a pro-small business platform and deploying the rhetoric of deregulation. Ideas include sunset clauses on new rules, simplifying employment law to make it easier to hire employees, and speeding up the process of starting a new firm.

Yet for every proposal to deregulate in the parties’ proposals there seem to be several measures that will actually increase bureaucracy and red tape, including much tighter controls on the financial sector and additional planning controls. Regrettably there are also hints of a new industrial policy, with talk of ‘rebalancing’ the economy away from banking and promoting ‘green’ industries with subsidies and tax breaks. This has echoes of the policies of the 1950s and 1960s when successive governments tried to ‘pick winners’ with economically disastrous results such as Concorde and the nuclear power programme. Those businesses not in the chosen field will inevitably suffer as taxes rise to pay for the government support and resources are transferred to the subsidised activities.

Then there is the European dimension. Much of the most costly new legislation emanates from Brussels and it is highly debatable whether the next UK government will be able to obtain sufficient influence to reverse this. More positively, there does appear to be a commitment to tackle the ‘gold-plating’ of EU regulation by British civil servants, but there is little detail on how this goal will be achieved in practice.

Furthermore, it is doubtful whether such a policy would make much impact on the really dark regulatory clouds on the horizon. Ambitious carbon targets and a tsunami of environmental measures mean that no matter who wins the election the costs faced by small businesses are likely to increase dramatically.

In particular, green policies are likely to lead to large hikes in energy and transport bills – making it still more difficult for British firms to keep their costs down in an increasingly competitive world. Taxes may also have to be raised if there is pressure to address greater fuel poverty through higher welfare benefits and state pensions. Accordingly, yet more business may be pushed out of the UK to lower cost countries such as China, a move that may speed up Britain’s relative economic decline while doing little to address climate change. In addition, these increased regulatory burdens are likely to lower economic growth rates, making it far harder for future governments to reduce the budget deficit.

Over-regulation therefore poses a grave threat to the UK economy, and the small business sector in particular. The issue should be a high priority for the next government if it wishes to reduce the barriers to innovation and entrepreneurship. Britain can have a thriving, dynamic economy, but only if deregulation is given priority in the legislative programme. This means taking a tough line against the bureaucrats in both Whitehall and Brussels.

Dr Richard Wellings is Deputy Editorial Director at the Institute of Economic Affairs.