The perception of taxes results in uncertainty that decreases investor confidence

A. Breeding Complexity and Uncertainty The good Catholic Sisters who saw to my moral instruction in primary school devoted many hours to the Ten Commandments. They wanted my classmates and me to avoid sins. Their success in that regard is in doubt. But at least the Sisters could be confident that we did not sin out of ignorance or uncertainty. How they would have instructed us on one million commandments, I do not know. The delinquents in my school found it hard to absorb a mere ten. There is a serious point here: The sheer volume and complexity of statutes, regulations, regulatory guidance, and tax code provisions – and their instability over time – are barriers to knowledge and comprehension of the law, sound planning, and avoidance of legal jeopardy. Just staying on the right side of the law has become a much more challenging and burdensome undertaking, especially for businesses. Thus, the enormous expansion of the regulatory state breeds complexity and uncertainty in economic affairs. Moreover, as the regulatory state expanded, regulators acquired great power to interpret statutes, transform broad and vague legislative mandates into specific regulations (i.e., laws), and exercise discretion in crafting and enforcing regulations. As the system grew more complex, interpretation and enforcement became more uncertain and the scope for capricious regulator conduct grew. In this vein, Epstein (2011a, page 150) argues that an expansive regulatory state undermines the rule of law: This expansion of the government’s purview undoes virtually all of the procedural and structural features of the classical system: unbiased decisionmaking, judicial review of administrative actions on matters of fact and law, and retroactivity.... [A]s the scope of government activities increases, the far-flung nature of these activities leads to a great desire to take shortcuts in regulation, such that the older protections are treated as obstructions against the march of progress, and not as protections of individual rights. In a similar vein, Cochrane (2015) argues that dramatic expansion of the regulatory state poses a danger to our political freedoms. He sees an “emerging threat of large discretionary regulation, used as a tool of political control.... Just who gets that visit from the EPA can have a powerful silencing effect.” In sum, a large and complex regulatory state also breeds uncertainty in economic affairs by raising risks that regulators will exercise their discretion in a capricious manner, or use it as a tool of political control. B. Disproportionate Burdens on Younger and Smaller Businesses The burdens of regulation and regulatory complexity tend to fall more heavily on younger and smaller businesses for three reasons. First, there are fixed costs of regulatory compliance. Whether a firm has one employee or one thousand, for example, U.S. law requires regular paperwork or electronic submissions in conjunction with payroll taxes and tax withholdings on behalf of workers. The fixed cost elements of regulatory compliance favor larger over smaller businesses. Second, there are one-time costs of learning the relevant regulations, developing compliance systems and establishing relationships with regulators. Young businesses have had less time to develop the knowledge and internal processes required for compliance. Partly for this reason, our current regulatory and tax systems favor incumbents while disadvantaging entrepreneurship and young businesses. Third, compared to smaller, newer and would-be competitors, larger and incumbent firms have greater capacity and incentive to lobby for legislative exemptions, administrative waivers, and favorable regulatory treatment. For this reason as well, regulatory complexity tends to favor large incumbents and disadvantage new, younger and smaller firms. Figure 8 shows the employment share of young businesses, defined as firms that hired their first paid employee within the past 60 months. The young-firm employment share fell by more than half in recent decades, from about 18 percent in 1987 and 1988 to just over 9 percent in 2013. This drop in the young-firm share is pervasive across broad industry groups and U.S. states.31 Although other factors are also in play, this evidence fits the view that the growing scale of the U.S. regulatory system has discouraged the development of new businesses.32 These arguments also imply that regulatory and tax complexity discourage existing firms, even large ones, from expanding into new markets and products. For this reason, greater tax and regulatory complexity tend to soften competitive pressures and repress creative destruction more broadly. Indeed, ownership has become more concentrated in most U.S. industry sectors since at least the late 1990s.33 The scale and complexity of the regulatory system and the tax code are among the drivers of greater concentration and softer competition in product markets. C. Negative Economic Effects of Policy Uncertainty There are also sound reasons for concern about the harmful effects of policy-related uncertainty. Because it’s typically costly to reverse an investment or hiring decision, greater uncertainty naturally prompts businesses to pull back from capital expenditures and job creation.34 Uncertainty also raises financing costs, further discouraging investment and job creation.35 Weak investments in new technologies, capital goods, product development, and worker training undermine longer-run growth. Motivated by this reasoning, my work with Baker and Bloom investigates the effects of policy uncertainty. Using firm-level data, we find that policy uncertainty raises stock price volatility in policy-sensitive and regulation-intensive sectors like defense, healthcare, financial services and infrastructure construction. We also find that increases in policy uncertainty brings reduced investment and employment growth rates for firms in these sectors. At the macroeconomic level, we find that upward policy uncertainty shocks foreshadow declines in aggregate investment, output and employment in the United States and other large economies. In short, our results indicate that policy uncertainty hampers economic progress. As we discuss in our 2016 paper, many other studies also find negative economic effects of policy uncertainty. D. Regulatory Uncertainty Also Undermines Regulatory Goals Viscusi (1983) provides a useful theoretical framework for analyzing the effects of regulatory uncertainty on investments in production capacity and quality. Firms choose a unit output level and a quality level. For given quality, costs rise with unit output. For given output, costs rise with quality. Here, higher quality includes things like lower pollutants per unit of output and lower health risks per unit of output and consumption. Let x denote the regulatory penalty per unit of pollutant, health risk or other negative by- product of producing or consuming the good. When investments are fully reversible, the effects of regulation are straightforward: A greater regulatory penalty x causes the firm to choose lower output and higher quality. Regulatory uncertainty generates no anticipation and uncertainty effects in this special case. Instead, output and quality respond to the regulatory penalty in place at the time. In the realistic case when investments are not freely reversible, uncertainty about future regulatory policy depresses the firm’s investments in both production capacity and quality.36 Negative effects on capacity reflect the possibility of a high regulatory penalty x in the future. Negative effects on investments in quality reflect the possibility of a low regulatory penalty in the future. For example, uncertainty about the future regulatory penalty on power plant emissions discourages current investments that would reduce emissions. In this way, regulatory uncertainty undermines regulatory goals.