Free & Clear: September 2012

For job growth, state should think small
By John Hood

Is North Carolina one of the best places in the country to do business? Or do we have a lousy business climate? You won’t find a more contentious issue in state politics. The Democratic nominee for governor, Walter Dalton, has the difficult task of arguing for continuity. He cites rankings that make the state look good. His Republican adversary, Pat McCrory, is advocating change. Naturally, he points to lists that make the economy look enfeebled and uncompetitive.

Both men have a case. Recent rankings by CNBC and Forbes and Site Selection magazines portray North Carolina’s economy favorably. But it doesn’t fare as well in studies by Bloomberg Businessweek and Inc. magazines. In the most recent Bloomberg Economic Evaluation of the States, North Carolina is near the bottom of the list in economic performance. One explanation is that, with so many rankings by a variety of organizations with different goals, they are bound to disagree. Another is that the interests of large, established companies are not always the same as those of small businesses and entrepreneurs. States attractive to some are not always appealing to others.

Take the issue of business regulation. According to Forbes, North Carolina has the country’s best regulatory climate. But the ranking is rather odd. While policies such as the state’s right-to-work law are properly included, the magazine also counts bond ratings, infrastructure and availability of targeted incentives. If you run a large company that can offset your regulatory costs with generous tax credits or cash subsidies from the state, this measure might make sense. But for the vast majority, judging the “regulatory climate” this way doesn’t. To them, incentives are unavailable or uneconomical. They are likely to agree with the findings of a more straightforward survey by the Kansas City, Mo.-based Ewing Marion Kauffman Foundation, which asked owners of several thousand small companies to rate their state’s business policies. In overall regulatory climate, North Carolina had the worst score in the South. Only 11 states ranked lower. It was also worst in the South and among the worst in the nation for business taxation.

The Washington, D.C.-based Tax Foundation has long ranked the state as having one of the nation’s most unfavorable business-tax climates, not only because of our high marginal income-tax rates but for the poor design of our retail-sales tax, which is often wrongly applied to business-to-business purchases. In its 2012 study, North Carolina ranked a miserable 44th. But in a separate report, Tax Foundation researchers created a model for estimating taxes paid by large businesses after accounting for targeted incentives. They found our state tax credits made a big difference in the final tally. North Carolina’s effective tax rate on long-established companies was the seventh-lowest in the country.

Taxes and regulations are hardly the only factors affecting economic growth. Businesses tend to prosper in states with low rates of crime, high rates of innovation and private investment, low land and energy costs, well-maintained infrastructure and a hardworking, well-educated workforce. Again, different companies have different needs. Thinking that there is just one good measure of the business climate is a mistake.

Ideology doesn’t explain the variation, by the way. The Tax Foundation is generally considered a right-of-center group. Two free-market think tanks, Fraser Institute in Canada and Boston-based Beacon Hill Institute, also produce annual state rankings. North Carolina does well in the Fraser study but only about average in the Beacon Hill report. They generally pull their statistics from the same sources but use and weight them differently.

Instead of continuing to tally up good grades and ignore bad ones, North Carolina leaders need to think about what really matters: economic performance. Given our relatively poor rates of job and income growth the past decade, any ranking that portrays the state’s business climate favorably deserves skepticism.

What is a good predictor? Entrepreneurship. States where people want to start businesses tend to have better economic performance over time, even though many new ones fail. Most job growth comes from startups, not mature companies. In the boom year of 2005, for example, U.S. businesses added just over 2 million new jobs. That was the effect of startups adding 3 million jobs and other companies shedding them. Basically, there would be no net job creation without entrepreneurs.

New companies usually don’t qualify for incentives. They don’t yet have the attention of politicians. And they are the most sensitive to factors such as regulatory compliance and marginal tax rates. North Carolina has a lot of room for improvement in our climate for small businesses and entrepreneurs — regardless of how many Site Selection lists we top.

John Hood is chairman and president of the John Locke Foundation. You can reach him at jhood@johnlocke.org.