Taxes, Licensing, and the Barriers to Small Business

Matt Yglesias makes some excellent points in his post about the impact of state-administered licensing requirements on small business growth. The general thrust of the piece is that contrary to conservative assertions that taxes pose the greatest barrier to small business growth, licensing is actually the greatest problem. The piece begins by dispelling the notion that new small business owners should worry more about taxes than anything else, despite what conservatives have typically suggested. Yglesias says:

To be charged a high tax rate on your small-business profits, you need to be turning a tidy profit in the first place. Anyone in that position would surely prefer lower taxes but is fundamentally ahead of the game. The main barrier to entrepreneurship is not that you’ll pay taxes if you succeed—it’s that you might not make any money at all.

He then goes on to describe a number of strange and unnecessary licensing requirements across the country, and concludes:

…a wide range of these rules could be done away with entirely at basically no risk. Regulation is needed when it would make sense for a firm to deliberately engage in malfeasance. Dumping harmful toxins into the air is highly profitable unless it’s prohibited. Financiers can draw huge bonuses by taking on too much risk, only to wreck the economy later. In other occupations, though, shoddy work brings its own punishments. An interior decorator who can’t get recommendations from satisfied customers probably won’t remain an interior decorator for long.

In these cases, licensing rules raise the prices the rest of us pay, make it difficult for successful entrepreneurs to expand their businesses, and are often a major barrier to employment for the most vulnerable populations. New Jersey’s ban on high-school dropouts fixing locks sounds silly, but given the generally bleak prospects facing workers with little education, barring them from whole occupations is a big deal. States should take a good, hard look at their existing codes and ask whether mass unemployment isn’t generally a bigger threat to the public than rogue barbers.

From a common-sense perspective I agree with just about all of this. Whatever the merits, licensing creates barriers to entry — just look at the legal profession. But folks who are already established in their industry have good reason to support licensing; it’s a way to keep potential competitors out through regulatory means rather than to have to out-compete them in the open market. And this kind of regulation-driven “soft competition” tends to be a burden on consumers, who invariably end up faced with less choice and higher prices. In many of the industries that Yglesias touches on — locksmithing, hairdressing, interior decorating, etc. — it seems to make sense to remove licensing requirements and basically go back to a blank slate so long as there is no demonstrable public health risk (as there seems not to be).

This looks to be a perfectly logical argument for restricting the scope of the licensing regime, if for no other reason than that a lot of these barriers aren’t needed, don’t promote competition, and don’t help upstart entrepreneurs or consumers. But I don’t see that any of this necessarily provides a prescription for bringing down unemployment. That’s because people who want to get into locksmithing or barbering or interior decorating — not just as a hobby but as their primary livelihood — have to deal with another barrier that is quite possibly more daunting than licensing requirements: they have to deal with finite demand.

As I think about my own neighborhood — Park Slope, Brooklyn (population roughly 65,000) — my guess is that there are not more than ten or eleven barber shops/salons/hairdressing boutiques within the neighborhood limits. In my home town in upstate New York of roughly 5,000 people, there were two barber shops, and while the ownership changed periodically that number stayed the same from the time I was five years old to the time I left home at eighteen. If you are in a business like cutting people’s hair, or fixing their locks, or decorating their homes, there are only so many customers you can have, and this is limited as much by geography and population density as by licensing and taxes. Yet, depending on your business model, you need a certain number of customers to remain in business, let alone out-compete the other shops in town selling the same service.

Certainly, removing licensing requirements and other unnecessary burdens might embolden folks to try to out-compete existing businesses, which would give entrepreneurs more of a sense of controlling their own fate rather than being nipped in the bud by arbitrary rules. But that doesn’t change the fact that there are limits on how many haircutting businesses can survive in a town of 5,000 people, or 100,000 people, or 10 million people, and those limits derive from factors that really can’t be addressed through legislation.

So, removing licensing requirements might be good for the general mood among entrepreneurs, it might be profitable for a number of cagey entrepreneurs across the country, it might be good for consumers, and it might even be marginally good for states with high levels of unemployment. But the greater the scale on which you try to reduce unemployment, the less the licensing regime appears to be a significant factor in that fight. Eventually you are butting up against the blunt reality that haircutting and locksmithing and interior decorating are low to zero-growth industries heavily constrained by population and geography. People aren’t going to suddenly need their locks picked more often if you remove the licensing barriers to becoming a locksmith, nor are a lot of prospective customers going to move into your town once they find out that you have opened up a barber shop. As an entrepreneur, you can out-compete and survive, which is great for you, but from a policy perspective that does absolutely nothing to address unemployment.

I don’t know what the licensing requirements for barbering are in New York State, but I doubt that removing them would allow my hometown of 5,000 people to suddenly support five or ten new barber shops. And even if it did, would the addition of 30-40 jobs really be that big a deal?