(FORTUNE Magazine) – AMERICA'S capitalism at its best -- the freewheeling, entrepreneurial kind -- has traditionally thrived most when it has been regulated with a light touch. Not unregulated -- laws have made the environment cleaner, the workplace safer, and the consumer healthier than the unguided invisible hand could have. But now the touch has become expensively heavy. In the regulatory arena America's admirable can-do spirit too often has become a must-do mentality: If it can be done, it must be done, regardless of the cost. Making matters worse, the process has become increasingly adversarial, partly because so much of it has moved into the courts. Regulation and vibrant economic growth don't have to be at odds. In nations we compete with, such as Germany and Japan, regulators more often work cooperatively with business. The goal is to solve problems, not fix blame. Constructive regulatory reform, in this spirit, deserves a place high on the agenda for the next Administration. Though the costs to the U.S. of regulation are impossible to pinpoint, the most comprehensive and widely accepted estimate comes from Rochester Institute of Technology economist Thomas D. Hopkins, a former Office of Management and Budget deputy administrator. He puts the 1991 pricetag at more than a half- trillion dollars -- nearly 10% of the nation's gross domestic product. The largest and fastest-growing components: health, safety, and the environment. Hopkins's estimate doesn't try to quantify the offsetting benefits. The total includes the good, the bad, and the ugly together -- nobody can calculate how much overregulation costs. But here's a clue. The U.S. will spend some $1.6 trillion on environmental cleanup during the 1990s, Hopkins projects -- roughly a third more in constant 1991 dollars than during the past two decades combined. The money isn't likely to yield the kinds of benefits the first tranche of money spent on environmental regulation bought us. The big gains have been won at costs that now look relatively low, and in many cases we're chasing after marginal improvements. Says Robert N. Stavins, an economist at Harvard's Kennedy School of Government and head of Project 88, a bipartisan environmental research group: ''Getting the next 5% improvement could send costs through the roof.'' A mere dollar reckoning of costs, moreover, doesn't measure the full weight of the federal regulatory burden. Says Robert W. Hahn, an economist at the American Enterprise Institute, a market-oriented Washington, D.C., public policy research outfit: ''The measurable costs of regulation pale against the distortions that sap the economy's dynamism. The public never sees the factories that weren't built, the new products that didn't appear, or the entrepreneurial idea that drowned in a cumbersome regulatory process.'' The burden is especially rough on the small companies that before the recession were the nation's great job generators. The National Federation of Independent Business, a Washington trade group representing some 600,000 smaller employers, has been polling its members about their biggest business problems for two decades. This year, for the first time, regulation rose to the top of the list -- ahead of taxes, the quality of labor, and the availability of credit. The smallest businesses are so overwhelmed now, says NFIB economist Thomas Gray, that they are taking to just ignoring the laws. ''They're saying, in effect, 'Catch me if you can. I'll pay the fine,' '' says Gray. ''We're very close to a breakdown in the public's acceptance of the government's authority.'' Small-business people are often the victims of regulations intended for large malefactors. The Financial Institutions Reform, Recovery, and Enforcement Act (Firrea) Congress passed in 1989 is a case in point. Bank regulators now insist that the lending institutions they oversee pay a federally certified appraiser to value real estate put up as collateral for any loan over $100,000. The average $5,000 cost of such an appraisal can price a small business out of the market. Typically, the entrepreneurs put up their homes, and the default rate on small business loans poses little risk to the banks. The banks themselves could do the appraisals at a tenth of the cost. Just trimming back the regulatory overgrowth would be difficult. But the next President will have to contend with major new laws -- such as the Americans With Disabilities Act and the 1990 Clean Air Act, which have yet to be fully translated into rules for business and local governments to meet. Paul R. Portney, a senior fellow at Resources for the Future, a nonpartisan environmental economics research group in Washington, says the act is one reason Americans will be spending 2.8% of GDP to comply with federal environmental mandates by the end of the decade. Germans are no less green and face a monumental challenge in cleaning up the former East. Yet, Portney estimates, Germany will be spending 1.6% to 1.8% of GNP. None of these estimates include the unknown potential cost of legislation being considered that would impose tough recycling standards on the packaging industry, or whatever actions are taken to tackle global warming. Since the challenge for public policy is to spend money where it will do the most good, federal regulatory reform should be guided by two objectives -- effectiveness and efficiency. Where to begin? First, by getting the agencies -- especially the Food and Drug Administration (FDA), the Occupational Safety and Health Administration (OSHA), and the Environmental Protection Agency (EPA) -- to set sensible priorities. Too many regulatory edicts are based upon unrealistic estimates of actual consumer, occupational, and environmental health risks. Most industrial countries limit exposure to hazards to tolerable levels. The U.S., by contrast, sets far more stringent ''virtually safe doses.'' This mind-set dates back to 1957, when the Delaney Amendment required that any known carcinogen be eliminated, no matter how small or limited the exposure. But British researchers Richard Doll and Richard Peto, whose work is widely accepted on both sides of the Atlantic, have found that fewer than 9% of all cancer deaths can be attributed to pollution, contaminants on the job, food additives, or medications. Smoking and bad diet, by contrast, may cause nearly two-thirds of all fatal cancers. Unrealistic goals can keep an agency from doing anything to improve safety. In 1989 OSHA tried to set standards for 428 common toxic air contaminants that, it estimated, could have saved some 700 workers' lives a year at an average cost of $1 million each. A federal court rejected the plan because it didn't set the requisite technically ''feasible'' limits. But to do that, OSHA would have had to run lengthy and expensive analyses of each contaminant. Result: no standards at all. The President -- any President -- could bring balance to the no-risk-too- small attitude with the stroke of his pen, argues Thorne G. Auchter, a former OSHA director who heads a nonpartisan Washington research group called the Institute for Regulatory Policy. All it would take is an executive order requiring agencies to write and revise rules on the basis of uniform, scientifically sound risk-assessment guidelines. These would be developed by the White House Office of Science and Technology Policy, headed by the President's science adviser. Thus determined, priorities would reflect the areas of greatest danger rather than the wishes of the interest group that makes the shrillest pitch to Congress. WITH RISKS more clearly defined, policymakers could better subject new regulations to rigorous cost/benefit analysis. It's not a new idea. President Jimmy Carter ordered executive branch agencies to evaluate the costs and benefits of their proposed edicts. Ronald Reagan established the Office of Independent Regulatory Affairs (OIRA) within OMB to review new mandates costing over $100 million and to suggest ways to make them more economical. Both of those promising efforts withered during the Bush Administration, though blame falls as much on Congress as on the President. The White House Council on Competitiveness, headed by Vice President Dan Quayle, has racked up a few successes in tempering regulation, but its resources are limited. More important, Congress and groups lobbying for regulation don't trust it because it is not subject to the same public disclosure process as OIRA. As part of the solution, Bush or Clinton should rehabilitate OIRA's authority. But Congress has to help out by subjecting pending legislation to cost/benefit tests before it becomes law. Says former Reagan Administration EPA director Lee M. Thomas, currently CEO of the Kennesaw, Georgia, consulting firm Law Companies Environmental Inc.: ''Right now Congress is more interested in dictating solutions than in defining the problems and measuring the damage they cause the private economy.'' And how. The Americans With Disabilities Act incorporates fuzzy goals based on undefined standards of reasonableness -- the courts will often have to decide what is ''reasonable.'' No one can guess the ultimate costs, especially since many will be determined by lawsuits. But the American Hospital Association, which gets its specifications from a presidentially appointed panel, has enough particulars now to estimate that its members will have to spend some $20 billion over the coming decade. That includes the tab for everything from enlarging parking lots and bathrooms to altering clinics and testing facilities. The results often aren't much better when Congress does spell out the solution desired. It sets ambitious targets and deadlines, then requires that federal agencies prescribe what equipment or processes companies use and how to use them. That command-and-control system works no better in regulation - than it does for companies that tell suppliers how to build a component. The best way to get creative solutions -- and to minimize harm to the economy -- is to harness the private sector's energies. The so-called tradable permits for sulfur dioxide emissions granted under the 1990 Clean Air Act are one example (see ''Next Steps for the Environment''). To speed up evaluation of new drugs, the FDA -- with the backing of the Council on Competitiveness -- contracts testing out to private experts. Now drugmakers have agreed that the agency should also charge fees for applications so it can afford to hire more reviewers. Congressional leaders hope they can pass the proposal this year. FOR AN INSTANCE of what's wrong with the current system, consider Prime Fiber Corp. of Appleton, Wisconsin, which reprocesses scrap used to manufacture recycled papers. Sitting on Prime's shelf is a promising new technology that would recover fibers from the waste sludge produced by pulp and paper mills, sludge that's now incinerated or dumped into landfills. Trouble is, the 1986 Resource Recovery and Conservation Act specifies that only paper that has been used in a consumer product may be reprocessed. Because the sludge is a manufacturing byproduct and thus falls outside the scope of the law, the EPA can't grant the waiver Prime needs without an act of Congress. Prime has been trying unsuccessfully to get one for three years. Americans don't like tough choices about health and safety any more than they like tough choices about taxes and spending. While Washington must not cave in every time the target of a proposed regulation squawks about the costs -- the targets usually imagine the worst when they first face the demands -- it has to acknowledge that the U.S., like every other country, can spend only so much in trying to ensure a better world. Particularly in straitened economic circumstances, that means being hardheaded -- and creative -- about where and how to regulate.

BOX: INSIGHTS

-- In a slow economy, America has to make tough choices about what rules it can afford. -- Hard science should be used to identify the greatest threats. -- Benefits of legislation must be weighed rigorously against costs. -- The regulators need an overseer in the White House.

CHART: NOT AVAILABLE CREDIT: SOURCE: THOMAS HOPKINS, ROCHESTER INSTITUTE OF TECHNOLOGY CAPTION: REGULATORY COSTS

CHART: NOT AVAILABLE CREDIT: FORTUNE CHART/SOURCE: W. KIP VISCUSI, DUKE UNIVERSITY CAPTION: HOW THE COSTS VARY