California: Is the “Business Climate” a Myth?

From the California Progress Report.

by Peter Schrag

The tired “business climate” argument that taxes and environmental regulations drive thousands of businesses and tens of thousands of jobs to other states should have been buried ages ago.

But in every recession, it rises yet again. Last week’s report from PPIC, the Public Policy Institute of California, therefore isn’t likely to drive the last nail into its smelly coffin, but you can hope.

The new report,  “Business Climate Rankings and the California Economy”, by PPIC researchers Jed Kolko, David Neumark, and Marisol Cuellar Mejia, begins with a simple question: Why is it that while “the state ranks poorly on many business climate indexes, particularly those in the taxes-and-costs cluster…California’s recent economic growth is near the national average”?

In trying to answer that question, the report makes graphically clear that the various rankings of states by different groups use so many different criteria that their collective assessment is more like a scatter diagram than an orderly ranking.  Thus California ranks fourth among the states on some rankings and 47th on others.

The authors also find that “natural advantages” – including a mild climate and the existing mix of industries – are far bigger drivers of the economy than taxes and regulation.

So while the researchers find that the complexity of the business tax structure – more than the tax rate– has some impact, it’s not nearly as significant as those natural advantages. But the report, despite its lengthy analysis, also either skirts or ignores other factors.

While it acknowledges that taxes “that increase the cost of doing business may also finance investments—such as transportation infrastructure—that support business growth” it doesn’t delve very deeply into the issue. Nor does it really weigh the importance of the many other public goods that might attract businesses, those who manage them, and foster innovation and enterprise: research universities, schools, parks, arts and cultural institutions, and countless other amenities.

Why is it that California, with comparatively higher taxes than Texas attracts 50 percent of all venture capital while Texas gets 4 percent? How crucial is the presence of a skilled labor force and a creative, innovative population?

The report itself addresses the university issue in a puzzling footnote whose terminology and syntax may be comprehensible to economists but isn’t likely to grab the attention of policy makers. “Our industry composition control variable,” it says in part, “likely already captures some of the effect of universities, and other elements of the higher education system—like community colleges…”  That’s not very helpful.

Kolko, in answer to questions about the possible positive effects of tax-funded public goods said those amenities may have an effect on regional economies but only indirectly on the state.

But would Silicon Valley have existed without Stanford and Berkeley? Would Central Valley agriculture have grown great without the huge publicly funded irrigation and flood control systems? Would the state’s trade-related enterprise have grown as great without the public investments in the ports of Los Angeles and Oakland? To what extent does the state’s whole economy depend on those industries?

More important still is the general claim by anti-taxers that California is a high tax state. Forty years ago, when it was booming, state and local taxes were among the highest in the nation.

As a percentage of personal income, they’re now somewhere between 14th and 18th among the states. And why is it that Nevada with the highest unemployment rate in the nation ranks higher in business climate than California, or that Florida with no state income tax has nearly half again (11.5 %) as many unemployed people, percentagewise, as the place they used to call Taxachusetts (8.2 percent)?

In studies going back to 2005, PPIC researchers determined that

“Contrary to popular claims, job losses from interstate business relocation are negligible. Although California lost more jobs from relocation out of the state than it gained from relocation of businesses into the state, the average annual job loss equaled only 0.06 percent of employment, or 11,000 jobs out of today’s economy of 18 million. Compared with other sources of job creation and destruction, job relocation is very small.”

What the new report makes abundantly clear, sometimes even despite itself, is the complexity of the issue – the variety of factors that confound the rankings and the uncertainty of their relative importance.

That in itself raises the question of whether such rankings – at least as they’re now constructed — can ever be reliable enough for making policy. What’s the trade-off between high taxes and great universities or reliable roads, between tight emission controls and clean air?

“Business climate” may not belong quite in the same set of myths as the claim that public sector unions are the cause of state fiscal crises or that cutting taxes on millionaires fosters economic progress, but close enough.  In effect, the rankings function principally as unscientific cudgels for ideological tax cutters, for corporate interest groups and for others on the right in what is – and always will, and should, be – a political debate.

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Peter Schrag, whose exclusive weekly column appears every Monday in the California Progress Report, is the former editorial page editor and columnist of the Sacramento Bee. He is the author of Paradise Lost: California’s Experience, America’s Future and California: America’s High Stakes Experiment. His new book, Not Fit for Our Society: Nativism, Eugenics, Immigration is now on sale.


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