Few subjects unite politicians across the political aisle like the imperative to reduce regulatory burdens on small businesses. Small firms are conceived of as “barber shops, beauty salons and pizza parlors” on Main Street and “farmers and ranchers, the sons and daughters carrying on the family business” outside of town.

They are lauded as the “heart and soul of the American economy” and the “embodiment of the American dream.” Yet, according to the conventional wisdom, they are “punished disproportionately” by federal regulations and in need of “a level playing field to have a fair shot.”

This narrative has potent political resonance, and it does contain more than a kernel of truth. But when it comes to discussing the many ways in which regulation actually favors small firms, politicians tend to fall silent. Examples abound. Small debit-card issuers are allowed to charge higher interchange fees to merchants than Chase or Wells Fargo. Small oil refineries can be exempted from renewable fuel standards that apply to Exxon and Marathon. Small telecom equipment and software makers can disregard accessibility requirements for disabled users to which Cisco and Motorola must adhere.

All told, over 1,300 federal statutory provisions bestow advantages on small firms. These provisions confer not only blanket exemptions (a relatively modest category), but also less rigorous monitoring, delayed compliance deadlines and fee waivers. Hundreds of these provisions mandate minimum levels of small-business participation in government programs. Hundreds more compel agencies to show special solicitude to small firms in administrative processes.

What’s more, many of these benefits are available not only to those proverbial barber shops and beauty salons straight out of Frank Capra movies, but to firms with hundreds of employees or tens of millions of dollars in revenue.

Considered in isolation, some of these advantages may seem minor. Viewed collectively, however, they challenge the prevailing narrative of small businesses beleaguered by regulation. This regime of preferential treatment for small firms – comprised of measures large and small, salient and subtle – raises questions concerning both the fairness and efficiency of a wide array of federal laws.

This article summarizes my academic research, for the first time documenting the massive body of federal laws that explicitly provide advantages to small firms. Indeed, this broad scope reveals a legal regime of small-business favoritism.

The costs of this regime are significant and often overlooked. Legal preferences for small firms undermine statutory objectives, channel public resources toward less valuable uses, generate unnecessary red tape – and, ironically, undermine firms’ incentives to grow to efficient scale. Meanwhile, the usual justifications for these preferences – that they create jobs, spur innovation and counter concentrated political power – are open to serious question. This has led me to conclude that the legal regime favoring small firms is ripe for reform that includes eliminating size-based carve-outs and adopting graduated obligations that increase with firm size.

The Overlooked Law of Small Business

The federal government’s solicitude for small firms is most visible in a handful of familiar programs, some of them very large. For example, the cabinet-level Small Business Administration helped to deliver over $100 billion in new capital to small firms on favorable terms last year. During the depths of the Covid-19 pandemic, the Paycheck Protection Program, available only to firms below a certain size, authorized more than $800 billion in forgivable (and thus heavily subsidized) loans.

Yet these high-profile examples are only the tip of the iceberg. My research team combed through the U.S. Code to identify every provision that singles out small firms for favorable treatment – not only explicit references to “small businesses” (or “small shipyards,” “small insurers,” etc.) – but also provisions that set thresholds based on employee count, revenue, assets or production volume. We then reviewed each provision to determine whether it confers a size-based benefit on private entities.

The result is a dataset of 1,311 distinct provisions spread across 302 separate laws and administered by 32 different federal agencies. These provisions fall into seven broad categories: training and technical assistance (415 provisions); loans, loan guarantees and grants (300); government contracting preferences (263); regulatory carve-outs (138); R&D support (92); international trade assistance (67) and tax relief (36). Put simply, Washington helps small firms build expertise, access capital, sell to the government, reduce regulatory compliance costs, profit from inventions, reach overseas markets and reduce tax burdens. Agencies advance these goals by:

• Creating offices or programs focused on small businesses (391 provisions)
• Informing Congress or the public of their efforts (201)
• Issuing regulations or otherwise adopting policies that favor small firms (115)
• Conducting studies at government expense (87)
• Soliciting input from small firms (44)

Some statutory interventions affect small firms in direct, observable ways: when Congress launches a new program or instructs an agency to adopt particular regulations, those decisions directly shape the conditions under which small businesses operate. Other provisions work more subtly. Mandates that agencies report their efforts to assist small businesses and requirements that they consult with small firms when writing new regulations leave the formal legal rules governing small firms unchanged but can still move policy in meaningful ways.

For example, a requirement that an agency confer with a small-business procurement advisory body does not in itself force the agency to change how it buys goods or services. But it gives small businesses a channel through which to press their views. Similarly, directing an agency to disclose the portion of its contracts going to small firms does not require that any particular procurement contract be signed. But it does make agency performance more visible to Congress and outside overseers, who can then use that information to demand changes or exert political pressure.

Congressional attention to small-business concerns has grown markedly over time. New small-business-favoring provisions proliferated rapidly from the late 1950s through roughly 1980. Beginning in the early 1980s the pace of new enactments leveled off, then began to climb again around 2000. The scale of this legislative expansion is striking: over the past half-century, the amount of statutory text dedicated to small business has grown approximately seven times faster than the rate of growth for all other statutory text.

What Businesses Actually Qualify as "Small"?

There is a further wrinkle that complicates the mom-and-pop vision: the firms that benefit from this legal regime are often considerably larger than the image of Main Street storefronts would suggest. Roughly 88 percent of these 1,311 statutory provisions adopt the small-firm size thresholds set by the Small Business Administration. And the SBA establishes industry-specific size standards for nearly 1,000 sectors.

In industries where the SBA definition is based on revenue, the industry-specific ceilings for eligibility as a small business range from $2.25 million to $47 million in annual sales, with a median of $21 million. In industries where the definition is based on headcount, the limits range from 100 to 1,500 employees, with a median of 825.

Under these capacious standards, enterprises with many hundreds of employees qualify as small businesses for many purposes under federal law despite these businesses being larger than the vast majority of American firms. The construction industry is illustrative. Firms in that sector can take in up to $45 million per year and still qualify for small-business benefits. Given that average net margins in construction run around 6 percent, the owner of a firm approaching this $45 million limit is likely to be doing quite well financially.

These revenue and headcount ceilings are at odds with political rhetoric about small businesses, which is replete with references to “Main Street businesses,” “family restaurants” and the like. The term “small business” thus does a great deal of rhetorical work. It invites sympathy by calling to mind genuinely modest enterprises, even though the legal rules frequently extend the same favored treatment to firms operating on a much larger scale.

The Governance Costs of Favoritism

Small-business favoritism is not just a question of rhetoric. It imposes real costs. I highlight three. First, many small-business carve-outs directly undermine the purposes of the statutes that contain them. The Fair Housing Act, for example, prohibits discrimination in housing – but it exempts small, owner-occupied rental properties. The explicit purpose of that exemption is to permit discrimination that the act would otherwise forbid.

For laws that prohibit or discourage harmful activity, exempting small firms makes little sense. A victim of housing discrimination suffers the same harm regardless of whether the property owner is small or large. The same is true for people protected by food safety rules, environmental regulations, and myriad other regulatory subjects that contain small-firm exemptions. As the legal scholar Paul Verkuil once observed, “It is cold comfort to the miner who contracts black lung disease or to the textile worker who inhales cotton dust” that his employer qualifies as a small business when it comes to workplace safety.

The problem can cascade. When small firms are exempted from, say, safety regulations, production may shift toward the exempted firms and away from their larger, regulated competitors. The net effect is not merely that some miners or textile workers receive less protection than others – it is that economic incentives push employment toward the less-protected firms.

Second, small-business preferences divert public funds from more effective uses. Take government contracting. Firms that win business on their merits tend to grow, with that growth reflecting demonstrated competence. Federal contracting preferences for small firms can invert this logic. More than 200 statutory provisions tilt the playing field toward smaller vendors, including a governmentwide requirement that small businesses receive at least 23 percent of federal prime contract dollars each year – a figure that now tops $100 billion annually. Meeting that target can mean passing over the most qualified bidder. Rather than rewarding capability, the system redirects public dollars away from firms that would prevail in competitive bidding and toward smaller firms with inferior bids based on price, quality or other criteria.

Grant and loan programs raise similar concerns. The Paycheck Protection Program is instructive. Aimed at preserving jobs during the Covid-19 shutdown, the program proved strikingly costly per job saved – estimates range from $169,000 to $258,000 per year. Much of this money flowed to creditors and business owners, many of whom were not considering layoffs, rather than to workers. Although some spillage was likely unavoidable given the speed at which the program was deployed, restricting eligibility to small firms added its own layer of waste.

Other developed countries took a different approach during the pandemic, subsidizing wages directly and limiting support to firms that had actually reduced work hours – a better signal of genuine financial distress. That model kept more workers employed at lower public cost.

The underlying principle generalizes: when public resources are scarce, establishing eligibility based on firm size rather than explicit need or impact produces inefficient outcomes. Across many regulatory contexts, size-based eligibility functions less as a policy tool than as an administrative convenience – one that often comes at a high cost to program effectiveness.

Finally, there are procedural costs. The Regulatory Flexibility Act of 1980 mandates that agencies across government analyze the impact of proposed rules on small firms and consider alternatives that are less burdensome to them. That procedural requirement has real teeth since courts can enforce it. Forty-four additional statutory provisions require agencies to consult with small-business advisory committees before finalizing certain policies. Another 201 provisions mandate reports to Congress or public disclosures about small-business concerns. And 87 provisions require agencies to conduct dedicated studies on the impact of their activities on small firms.

Add it all up and agencies must jump through a bewildering number of procedural hoops related to small firms before they can act. Legal scholars argue that loading agencies with procedural requirements of this kind produces “ossification” – unnecessary delay, excessive caution and an overall reduction in effective governance. At a time of renewed focus on reducing red tape in government, the cumulative burden of these procedures deserves scrutiny.

A Hidden Tax on Growth

Perhaps the most economically significant cost of small-business favoritism is one that rarely enters political debate: it discourages firms from growing.

When crossing a size threshold means losing valuable exemptions and benefits, rational business owners have an incentive to remain below it. Prior research has documented precisely this sort of clustering below eligibility caps. In banking, financial institutions tend to bunch just below $10 billion in assets – the cutoff for several important regulatory exemptions – and below $500 million, where mandatory annual audits kick in. In securities markets, many firms manage their public float to stay below $75 million and thereby avoid more extensive disclosure requirements. Similar dynamics are present in European labor markets around thresholds that activate specified job protections.

My research adds new evidence to this picture. Using a commercial dataset covering roughly 50 million U.S. firms, I identified the distribution of firms relative to their sector-specific Small Business Administration headcount thresholds. The figure below displays the distribution of firms whose employment falls within a band ranging from 50 employees below to 50 employees above their industry’s eligibility cutoff for small-business status.

Consider, for example, Blue Bird Corp., the school bus manufacturer, with 1,550 employees. The SBA threshold for automotive and light-duty motor vehicle manufacturing is 1,500 employees. Blue Bird sits 50 employees above the cutoff. Therefore, it is located as part of the bar at x = 50.

This figure shows that firms tend to cluster just below their industry’s eligibility cutoff. Statistical analysis reveals that the pattern is well beyond what random variation would produce. That clustering is consistent with firms deliberately limiting their headcount to retain small-business status. The figure also shows a greater concentration of firms with 1-50 employees below the cutoff than firms with 1-50 employees above it. That asymmetry provides further evidence that firms organize themselves to remain under the threshold.

The reality that firms cluster immediately below the cutoff to remain eligible for regulatory benefits entails a genuine social cost. Firms that cap their growth to preserve privileges are forgoing expansion that might otherwise be economically efficient and socially beneficial. The benefits of small-firm status accrue to the owners; the foregone growth is a loss to workers who would have been hired, to consumers who would have been served and to the economy at large in terms of aggregate productivity.

Questioning the Justifications

The standard defenses of small-business favoritism rest on two pillars: fairness and economic dynamism. Neither is as solid as it may seem. The fairness argument begins with the premise that large firms enjoy economies of scale in regulatory compliance. They can spread the largely fixed costs of dealing with monitoring and adhering to regulation across more units of output, while their smaller competitors cannot. From this perspective, exempting small firms simply levels a playing field that is already tilted against them.

The empirical picture is more complicated. Drawing on detailed occupational data for 1.2 million establishments, a trio of researchers found that regulatory costs per employee do not simply decline with firm size. Instead, they rise as firms grow from sole proprietorships to a range of around 250-500 employees, then decline somewhat for the largest firms. Firms with more than 4,000 employees face per-employee compliance costs roughly comparable to those with 20-49 employees. The straightforward, linear economies-of-scale story is just not accurate.

The fairness argument also has a political variant. Proponents of small-business favoritism argue that large firms wield disproportionate influence in Washington – specifically, that large companies with deep pockets can hire armies of lobbyists, make large campaign contributions and entice former government officials with employment opportunities to an extent that smaller firms cannot match. In this telling, small firms’ statutory advantages can help address this imbalance in political resources.

There is something to this. Still, small businesses are far from powerless. They operate in every congressional district in the country, giving them a kind of distributed geographic clout that big players in concentrated industries lack. For instance, community banks – a defined category of smaller banks subject to less stringent regulation – are present in every congressional district. Often, their officers and directors are local notables with whom the area’s politicians are friends and neighbors. Perhaps not coincidentally, regulatory relief for community banks has long been a bipartisan project in Washington.

Further, surveys consistently show that small businesses enjoy the highest level of public trust of any institution in America – a reservoir of goodwill that may translate into political leverage. In any event, trade associations for small firms in many sectors are formidable political actors. In fact, the evidence is mixed regarding whether firm size and lobbying activity are correlated. Whether small firms, on balance and in the aggregate, suffer a political disadvantage vis-à-vis large firms is thus very much an open question.

Then there is the economic dynamism argument. Here, proponents claim that small firms are an outsized engine of job creation and innovation, and therefore deserve special regulatory support.

This claim is repeated so often in Washington that it has become a mantra. It is nonetheless misleading. Although small firms do account for a disproportionate share of job creation, this effect is largely driven by firm age, not firm size. New firms tend to start small, with those that prosper then growing and hiring new employees; established small firms do not. Once one controls for firm age, the statistical connection between firm size and job creation evaporates.

The innovation story is similarly overstated. Groundbreaking innovation emerges from a range of organizational settings: university laboratories, large corporate R&D departments, government-funded research programs and, yes, small startups. Apple built its first computers in a garage. But it created the iPhone decades later only after it became a corporate behemoth. And the internet – which makes Apple’s phones, tablets and watches truly transformative – was developed through federal investment.

Scholars have long debated whether small or large firms are more innovative in general. The economist Joseph Schumpeter argued that large firms operating in concentrated markets are better positioned to drive innovation because they can absorb the fixed costs of R&D, diversify across projects to hedge against failure and exploit economies of scale in translating discoveries into commercial products. Indeed, empirical evidence indicates that R&D spending tends to increase along with firm size. But others have countered that bureaucratic inertia and reduced competitive pressure blunt large firms’ innovative instincts.

In any case, few small businesses are focused on innovation. A survey of small business owners shows that most do not invest in R&D, pursue patents or even trademark their firms’ names. Once firm age is accounted for, small firms are no more innovative than large ones, on average. Small firms that do generate significant innovations tend not to stay small for long.

What Should Change

None of this means the federal government should drop all preferential treatment of small firms tomorrow. For some provisions, the benefits of favoritism plausibly – and, perhaps in some cases, certainly – exceed the costs. The question is whether each provision deserves its place in the legal code. On that question, the current political consensus has been far too credulous.

The most compelling case for reform involves ending exemptions from laws designed to address serious social harms. When a statute prohibits conduct because that conduct harms others, the size of the actor is virtually irrelevant to the moral calculus. A small business that dumps a given amount of waste imposes the same environmental costs on neighboring communities as a large firm that does the same.

Environmental laws exist in part to compel firms to internalize this type of negative externality. By exempting small firms, Congress shifts those costs from the firm to the affected communities or the public. Someone has to pay when a firm pollutes, and the question is whether that cost should fall on the polluting firm or on others.

The argument that exemptions are needed because compliance is burdensome for small firms doesn’t bear scrutiny well. If a firm cannot compete without transferring part of its production costs – including the costs of properly disposing of waste, reducing workplace injury risk to an acceptable level and otherwise internalizing negative externalities – onto others, then the firm’s goods and services are better supplied by rivals that can. Simply because certain firms are less equipped than others to adhere to laws that promote the public good does not, by itself, provide a sound reason to weaken those laws for these firms.

To be clear, I am not arguing for more regulation per se. By requiring firms to internalize the cost of pollution rather than offloading it onto the public, the hypothetical law discussed above is socially beneficial. But if a law does not promote the public good, then exempting small firms but requiring compliance from larger ones is inadequate – and that law should be stricken from the books. A political culture that encourages small-firm favoritism gives lawmakers permission to avoid hard questions about whether a law actually benefits society overall, when they can instead just exclude well-regarded small businesses from its ambit.

Going further, eliminating small-firm exemptions could be coupled with trimming legal obligations across the board. This idea borrows from the logic of tax policy. In that domain, broadening the base by eliminating narrow exemptions allows for tax rates to fall for every taxpayer while still collecting the same amount of revenue. Applied to regulation, pairing the removal of small-firm exemptions with modest reductions in applicable standards for all firms could hold the overall regulatory burden constant while distributing it more equitably. Firms that benefit from special regulatory treatment under the current system and firms that bear the full cost would converge toward a more even treatment.

For situations where the complete elimination of an exemption would be unduly disruptive, graduated frameworks offer a middle path. Rather than a binary cutoff – fully exempt below the threshold, fully subject to the law above it – lawmakers could phase-in obligations as firms grow, with the steepest requirements reserved for the largest players.

Once again, tax policy offers a template. The federal income tax is progressive: taxpayers move through multiple brackets as income rises. In some areas, regulatory obligations could follow the same framework. Such a structure would preserve relief for genuinely small enterprises while reducing the perverse incentive to stay artificially small just to avoid crossing a daunting threshold.

For laws aimed at negative externalities like pollution, a third option is particularly attractive: allow firms to choose between (a) complying with the applicable standard and (b) paying a fee calibrated to the actual social harm their noncompliance causes. This approach preserves the incentive for firms to internalize costs that make such regulations valuable while accommodating the genuine variation in compliance costs across firms of different sizes.

The Rhetoric Problem

Alongside these structural reforms, there is one simpler change that the debate over small-business policy needs: honest rhetoric.

Politicians who advocate for small-business preferences routinely invoke images of the small-town grocer, the neighborhood restaurant, the family farm. These images are emotionally resonant and politically effective. They can also be misleading. When the governing definition of “small business” encompasses firms with $47 million in revenue or 1,500 employees, political rhetoric does not reflect reality. Public support for these provisions almost always rests in part on a misunderstanding of who actually benefits from them.

There are two potential responses to this disconnect. One is to change eligibility thresholds so that they do actually correspond to the kinds of enterprises politicians invoke when making the case for special treatment. The other is to be straightforward with the public about the fact that many beneficiaries are not Main Street storefronts and the like – and then to make the affirmative case for why such firms still deserve preferential treatment. What is not defensible is continuing to justify policies that benefit firms with hundreds of employees or tens of millions of dollars in revenue by pointing to “the barber shop with the first dollar bill still taped to the wall.”

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Small businesses occupy a hallowed place in American civic culture. They represent entrepreneurial ambition, community rootedness and the possibility of building something from nothing through hard work and ingenuity. That image has translated into an extensive but largely invisible system of legal privilege available to firms far larger than any plausible sense of “small.”

The rationale for this system is questionable. The costs of small-firm favoritism in terms of diluted societal protections, inefficiently allocated public resources, procedural burdens on agencies, and incentives for firms to stay small are real and substantial. The purported benefits – job creation, innovation, leveling a tilted playing field – are harder to pin down.

To be clear, this analysis does not support wholesale elimination of every small-business preference on the books. But it does suggest that this legal regime is due for an audit, a rigorous review of whether each provision is actually doing what its proponents claim at a cost to the public that is worth bearing.