Role of Government in Business

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States frequently create various regulations and rules that dictate how business is carried out in their territories. Large and small companies must alter how they run their operations because of shifts in federal policies. Business regulations, as well as government policies, have a notable impact on both profitability of organizations and also their competitiveness. Yet, business owners and managers must adhere to the existing regulations and guidelines at all levels. The important way the governments influence the market environment is by establishing monetary and fiscal policies. By controlling and monitoring the interest rates, the government can ensure that funds for capital investments and loans are available to businesses. However, this type of control indirectly influences unemployment and inflation rates. Governments also have the ability to exercise direct control on businesses through the application of quotas and tariffs on both imports and exports. Quotas are created to either increase or lower the quantities of specific products leaving or entering the country, which either reduces or increases competition in certain industries. The lowering and increasing of tariffs enable the government to control certain industries by making it more expensive or less capital intensive for business to trade in foreign products (Beach & Jones, 2016, p. 295). New regulations and policies enacted by government also influence business operations. Government policies restrict or hinder the operations of businesses, which has a negative impact on profitability. Government policies also make it difficult or easy for new organizations and businesses to enter into various industries.

How does government activity affect businesses?

Occasionally, government policies often result in changes in how businesses behave socially. For instance, the taxation of carbon-based fuels and the granting of subsidies for organizations that make use of renewable energy have a significant on how different businesses operate. Governments also have the ability and power to underwrite the development of modern technology to influence change in the social environment of most businesses. The levying of more taxes on a particular sector than what is required often leads to lack of interest among potential investors. Moreover, tax and duty exemptions in certain sectors could trigger increased investment and growth (Jiun-Shiu & Lovvorn, 2012, p. 58-60). For instance, levying high taxes and duties on imported products could result in increased domestic production of the same item. However, high duties and taxes on the importation of raw materials could hamper domestic production.

It is critical to note that government policies are often influenced by the political culture prevailing at the moment. In this regard, policies that are created in politically stable nations are often different from those passed in unstable countries. Stable political environments often create friendly government policies that encourage business growth and attract foreign direct investment. Unstable political climates often have numerous challenges that compromise the ability of governments to effectively implement law and order (Gould, 2002, p. 122-125). This often has an adverse impact on businesses. Governments are often funded from the taxes levied within their jurisdiction (Shokeen & Banwari, 2013, p. 68-70). Therefore, increased public spending necessities an increase in taxation and borrowing in the domestic market, which starves businesses of credit. Increased taxation tends to scare investors, especially among entrepreneurs. Increased taxation also reduces the amount of income individuals and businesses can save to reinvest in business activities. Research has demonstrated that a reduction in private saving also adversely affects the production of services and goods.

Government policies significantly affect interest rates in the economy, which could result in an increase in the cost of credit. Higher interest rates also adversely affect consumer spending leading to low sales. In contrast, low-interest rates encourage more investment and higher production. Governments have the ability to monitor and control the prevailing interest rates through the printing of more money that could ultimately lead to inflation. However, businesses are severely affected when there are high rates of inflation. Other government policies such as the federal minimum wage, trade regulations, and the requirements for issuing licensing and permits have a significant influence on the operation of businesses (Down, 2012, p. 620-624). For instance, periodic inspections from regulators of health standards are conducted in all restaurants and hotels, which forces such businesses to spend and invest a considerable amount of their resources to satisfy and comply with these regulations. Nonetheless, fair and effective regulations encourage business growth.

A critical component of government policy is the function it plays in the economic policy of the nation. From 1945 to 1979, the US government increased its interference in the American economy by establishing state-owned industries that were similar to public corporations. Nonetheless, from 1979 the government embarked on a privatization agenda that facilitated the sale of public corporations to private investors and shareholders to encourage competitive business practices. Taxation has a significant impact on business costs. For instance, an increase in corporate taxation has similar effects as a rise in business costs, and hence lowers profitability. Other business taxes such as VAT and landfill tax also adversely affects business operations (Chang & Lu, 2015, p. 15-18; Matthews, 2003, p. 110-112). Even though the cost of Vat is passed down to the final consumer, the administration costs of levying this tax falls on the business. Interest rates are determined by government appointed monetary committees that deliberate and set the rates on a monthly basis. Any increase in the interest rates leads to a similar increase in the cost of credit and borrowing money. It also has a negative influence on consumer expenditure patterns.

Furthermore, governments often review and adjust their policies to conform to the existing market and political situations. As a consequence, businesses are forced to continuously evaluate and react to changes in the legal environment. Some of the legal changes that businesses have to react to include adjustments to the national minimum wage, regulations requiring organizations to cater for the disabled in the workforce, the legislation of stringent regulations to govern competition, as well as more provisions to protect consumers (Marshall & Piper, 2005, p. 146-149).

How can large companies and Small and Medium Enterprises (SMEs), respectively, exploit this influence and/or defend themselves from it?

However, not all government policies adversely affect business practices. Some scholars argue that the benefits that accrue to businesses due to government activities and policies often exceed the cost implications. Even though they might have a negative impact on some businesses growth and profitability, they also generate better competitive conditions that encourage growth (Mossner & Gassner, 1999, p. 95-98). Some of the strategies used by large and medium organizations to exploit or avoid some government regulations include transfer pricing strategies, use of trademark holding companies, as well as captive REITS.

Transfer pricing strategies are applied by organizations that are taxed based on their profits. In this regard, to minimize the amount of taxation a company has to pay, they devise creative means of lowering reduce their reported net profits, especially when operating in highly taxed countries. This implies that the profits are shifted to sister companies that operate in low taxed regimes. This is achieved by large multinational companies when a legal entity is registered in a low tax country. Thereafter, the rights of its intangible assets are assigned to the newly registered entity in a low tax area (Pergelova & Angulo-Ruiz, 2014, p. 665-669; Marshall, 2005, p. 7-11). This implies that the parent country is forced to pay royalties to the new entity because of using its intangible assets, which helps the parent company to repatriate profits to a low-tax regime country. However, the amount of funds it should pay in royalties is very difficult to determine because intangible assets are valued in a complex manner. This loophole allows the company registered in a high tax nation to attain higher expenses that significantly reduce its profits due to the payment of royalties (Kessler & Kelley, 2000, p. 46). The income generated from the payment of royalties is then recorded in the new entity registered in a low taxation country, which facilitates transfer of profits to low tax locations.

The transfer of pricing approach mentioned above is not just used to avoid taxation. Some versions of the same strategy can be used to evade interstate income taxation. The principle is the same; trademarks are assigned to another holding company operating in a low taxation country. Therefore, the company operating in a high tax country is forced to pay arbitrarily high royalty charges to the holding firm that has the patent rights, which significantly decreases its net income. The state of Delaware is often selected in the US because of its low tax regime (Mokry, 1988, p. 86-90; Fernando, 2011, p. 178-180). The state does not impose any kind of taxation on passive investments, which encourages most companies to shift their profits to Delaware. A classic example of the implementation of this strategy was the Geoffrey Inc trademark holding firm created by Toys R Us. Toys R Us was a South Carolina company that paid royalties to Geoffrey Inc, and hence effectively reduced its net profit in the state of South Carolina. The state decided to sue the company in the Supreme Court which upheld that South Carolina could tax the royalty payments made by Toys R Us to Geoffrey Inc, which has negated this practice. Nonetheless, the practice continues in other states that have not devised a means to negate it.

Captive REITs are similar in tact to the strategies mentioned above. They try to inflate the paper expenditure of the organization. In order to use this strategy, a business needs to transfer its real estate assets to a REITs, which is often owned by another subsidiary of the company. Through this strategy, the firm is obligated to pay rent charges on its real estate to the REITs, which significantly reduces its profits. However, REITs are not required to pay any taxes on their rent income as long as more than 90% of their profits are distributed to the shareholders as dividends (Kozami, 2005, p. 120-124). In addition, dividends cannot be taxed on corporate entities.


Even though the IRS and other bodies charged with the responsibility of administering taxation have made attempts to negate tax avoidance, the laws governing taxation are usually voluminous and complex, which makes it very difficult for tax agencies to fully monitor tax avoidance. Despite tax avoidance being ethical moral, it is not illegal, and hence companies are free to use it to maximize their profits.


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Shokeen, S., & Banwari, V. (2013). Impact Of Government Policies On Development Of Women Entrepreneurship In India. CLEAR International Journal Of Research In Commerce & Management, 4(11), 66-70.

October 12, 2022

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