3. What Are Compliance Costs and Why Are They Important?
Regulation is a key factor in helping government achieve its economic, social, and environmental goals. It has been seen as necessary to deal with market failures in areas such as environmental quality, working conditions, workplace health and safety, equal opportunity, consumer protection, product standards and safeguarding competition. However, concerns are frequently voiced about the level of compliance costs imposed on business by government regulation, legislation, and form filling.
Compliance cost reduction is not a new issue. Most government departments have been seeking to reduce them, sometimes as part of major reviews of policy. There is, nonetheless, scope for a more comprehensive and co-ordinated approach across the public sector as a whole. In addition, it is important that compliance costs are kept down as new policies are brought in. The requirement for a BCCS will help ensure that the compliance cost implications of policy proposals are made explicit and properly considered in developing policy in a consistent and comprehensive way.
Objectives of Business Compliance Cost Statement
Compliance costs arise from most government interventions. However, businesses, other organisations and private individuals should not incur more compliance costs than necessary. This requires an increased awareness of the balance between the costs of compliance and the objectives of government policy. In practical terms, this means compliance costs will be given due weight with other costs and benefits when new laws, regulation, and administrative processes are being designed. The new requirement for a BCCS will help ensure that business compliance costs are given adequate upfront consideration in developing policy.
Why Compliance Cost Reduction Is Important
Growth, Competitiveness, Innovation
The compliance costs of most individual regulatory measures may be quite small, but their cumulative effect can be a real problem.
Compliance costs can:
- discourage growth and employment by diverting the energies and resources of firms from more productive uses, and deflecting their focus from their core business;
- be passed on to consumers through higher prices, with possible distributional and equity consequences;
- erode international competitiveness where overseas firms face lower compliance costs; and
- discourage compliance. This harms the working relationship between business and government, and gives those who don't comply a competitive advantage over those who do. It can also undermine the achievement of the policy objective.
Because compliance costs can act as a brake on business achievement, they can have a real impact on the government's key social and economic objectives. The benefits of reducing costs include stronger enterprises, higher growth and higher employment levels.
| Compliance costs divert private resources to public purposes, where the costs of such government requirements amount in effect to a regulatory tax; with similar economic effects as explicit (fiscal) taxation. Recent overseas studies have estimated direct compliance costs at between 4%-12% of GDP (OECD, 1997). These costs tend to fall disproportionally on Small Medium Enterprises ("SMEs"). |
Disproportionate Burden
The amount of resource needed to meet a regulatory obligation may bear little relation to the size of the organisation. For example, the cost to small firms of determining their health and safety obligations is likely to differ little from that faced by large factories.
In this way, compliance costs place a particularly heavy burden on small to medium-sized enterprises (SMEs). They are less able to employ specialist staff to meet regulatory obligations and this can affect their ability to comply cost-effectively. Moreover, the cumulative compliance burden falling on SMEs distracts owner/managers from running and growing their businesses.
Small and medium-sized businesses are also less likely than large businesses and government agencies to be represented during the policy-making process. They lack the time and resources to understand and make submissions on proposed legislation.
| More than 95% of New Zealand businesses employ fewer than 20 people, and 84% employ fewer than five. Collectively, small and medium enterprises account for 42% of all employees, and contribute 35% of all output (sales and other income) to the economy. Reducing compliance costs - both material and less tangible - will increase the productivity and effectiveness of these enterprises. |
Causes of Excessive Compliance Costs
Excessive or unnecessary compliance costs can be caused by a number of different factors:
- not enough consideration being given to compliance cost issues in policy development
- an inherent bias to regulate - especially where compliance costs are difficult to identify and/or quantify
- the tendency for those designing and monitoring regulations fail to take into account the perspective of business, particularly small business
- duplication or conflicts between obligations imposed by different Acts that have not been identified during the policy making process.
Problems may arise because of the act or regulation itself. Problems could include:
- overly complex regulations, processes and forms
- failure to tailor compliance requirements to different types of enterprise, and failure to acknowledge the different impact of costs on small to medium-sized enterprises compared to large ones
- lack of regular monitoring and review of whether government agencies continue to need specific information obtained from business
- not enough explanation of the rationale or justification behind a particular obligation
- inappropriate, insufficient, or inaccessible information about the key features of new measures and what they mean for individual companies (particularly with new and/or complex legislation)
- insufficient use of technology for transferring information from businesses to government and within government.
What Are Compliance Costs?
Meeting Obligations Imposed by Regulation
There are three broad categories of regulation:
- regulations that facilitate the collection of taxation or other monies by the government (such as PAYE, ACC levies, student loan repayments);
- regulations that require businesses to record information or submit information to the government (such as statistics, company returns), or disclose information to third parties (such as company financial reporting requirements);
- regulations that impose obligations on business for the benefit of third parties (that is, regulation regarding matters such as consumer rights, environmental sustainability, health and safety, anti-discrimination, border control).
The first two bullet points are requirements that create administrative responsibilities, while the third bullet arises from requirements that place protective obligations on business, and generally requires the business to change the way it operates in some way. In many cases, a single regulation will contain elements of both administrative responsibilities and protective obligations.
A Working Definition
Compliance costs are the administrative and paperwork costs on business in meeting these government requirements. They include both the administrative burdens and all other compliance costs, such as equipment purchases, retooling, and recurrent production cost. Compliance costs are distinct from the direct costs of any government requirement, such as the amount of tax payable.
Compliance costs of a regulatory proposal are only those incremental costs that arise from that proposal. They do not include costs from activities that would have been carried out anyway.
Some Costs Are Less Tangible
Compliance costs include the costs associated with identifying and understanding the regulatory requirement and may include costs of buying in specialist services (such as accounting, legal, computer systems, research), employing new staff to satisfy regulatory obligations, training staff and monitoring compliance.
At a less tangible level, costs can arise from increased liability because of new legal obligations, such as health and safety requirements.
Some Are Non-Quantifiable
The need to comply with government requirements can also have non-quantifiable effects such as stress and anxiety, often referred to as "psychic costs". These effects arise from uncertainty about obligations.
Businesses can also incur higher compliance costs than necessary because of poor management systems and skills, due to lack of experience, capabilities or equipment.
Compliance Cost versus Administrative and Economic Costs
Compliance costs can be distinguished from the administrative and the wider economic costs of regulation:
Administration costs. These are borne by public agencies (and ultimately, the taxpayer) in administering the regulation or law. They include the costs of formulating standards, monitoring and enforcing compliance, and adjudication.
Economic costs. The wider economic costs of regulation are less tangible and relate to the dynamic, rather than the static, effects on resource allocation. That is, how does regulation distort the behaviour of individuals, firms, and industry generally and goes to the notion of economic efficiency. Welfare losses arise from regulation which impairs competition, stifles innovation, artificially constrains pricing behaviour and generally restrains the economic activity of individuals and firms.
There are likely to be instances where the definition of compliance cost fails to provide a clear indication whether a particular impact is a compliance cost or not. Making a clear distinction is not critical as long as the particular impact is included as a cost element somewhere in the total analysis of the proposed policy. In general, if you are unsure whether a cost to business should be categorised as a compliance cost or a direct cost, include it in the BCCS. If an identified cost is not included in the BCCS, it should still be discussed in the RIS.
Relationship with the Regulatory Impact Statement
Not Compliance Cost Reduction at Any Cost
The overall costs of government action have to be set against the expected benefits. A fundamental requirement of sound policy analysis is that the expected benefits to society as a whole from government action will exceed the overall costs. Regulatory Impact Analysis (RIA) is used to demonstrate that there is a net-benefit associated with any proposed regulatory intervention.
| Net Benefit = Benefits less Costs (administration/compliance/direct/economic) |
It is important to note that compliance costs are but one, albeit important, element of the overall costs which arise from any regulatory intervention. Therefore, policy-makers must give consideration to all the effects that the policy may create, including any compliance cost. The various effects of a policy (its cost and benefits) are also closely related, with changes in one often affecting another. As a result, changes designed to address compliance costs need to be considered in the light of:
- the effect on the benefit of the policy - for example, abolishing a tax removes the compliance cost but also the revenue from tax. Similarly, abolishing health and safety requirements in the work place risks accident or death;
- the effect on overall administration costs - for example, allowing businesses to provide information in flexible formats. This may reduce compliance costs at the expense of greater administration cost; and
- different types of compliance cost - for example, new initiatives may increase the initial start-up compliance costs but can lower on-going costs. For example, using electronic means for sending information to the regulator.
In designing policy, policy-makers need to ensure that the overall mix of costs and benefits provides the greatest net benefit to society. Compliance cost reduction is unlikely to benefit society if it is made the sole objective of major changes or pursued in isolation. In orderto assess which trade-offs are worthwhile, information on the extent and nature of compliance costs is required. Poorly considered changes could increase other costs unnecessarily and reduce the potential benefits from any measure.
Free Post Envelopes - the administrative/compliance cost trade-off Often compliance costs can be transferred from the private sector to the government as administration costs. For example, the provision by government of freepost envelopes transfers the cost of sending information or payments from the business to government. A number of factors may affect this decision: for example, the risk of non compliance may be high and costly to government; compliance rates will higher with freepost envelopes; bulk freepost discount rates available to departments may be lower than those available to business. |
The BCCS and the RIS
For these reasons, the BCCS is a sub-set, albeit an important one, of the cost benefit analysis required in the Regulatory Impact Statement (RIS) to accompany all regulatory proposals, and as such is included in the RIS.
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