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How Good Is Ohio’s Business Climate?
YOUNGSTOWN, Ohio -- Ohio has the third-best business climate in the United States. No, the Buckeye State has the third-worst. No, wait, Ohio ranks fifth. No, 18th. 45th. No, 39th. What’s going on here? Six studies. Six rankings.
And they’re all pretty much meaningless, says Peter Fisher, research director of the Iowa Policy Project who has served as a consultant to the Iowa Department of Economic Development and the state of Ohio.
In the second edition of his study, “Grading Places: What Do the Business Climate Rankings Really Tell Us?” Fisher begins, “An examination of the four most prominent ‘business climate’ ratings of state tax systems finds them to be deeply flawed and of no value to informing state policy.”
His report, issued in May and disseminated by the executive director of progressive group Good Jobs First, Greg LeRoy, finds the reports “display no predictive value about economic growth … [and] come to highly inconsistent findings among themselves. And to its discredit, one index includes data made up of whole cloth.”
In his preface, LeRoy writes, “Indeed, the underlying frame of these studies – that there is such a thing as a state ‘business climate’ that can be measured and rated – is nonsensical.”
LeRoy spoke at Youngstown State University March 22, 2011, on “Economic Development in Hard Times: How to Spend Less and Get More.” He remains highly skeptical of the importance tax breaks play in a company’s decision to stay, stay and expand, move elsewhere or expand elsewhere. “Tax breaks for businesses are badly reported and little understood,” he said that evening. Moreover, the tax breaks governments offer “are biased against small entrepreneurs.”
The six studies, each giving Ohio’s business climate a different ranking, focus on the role of taxes to determine how inviting or hostile a state is to business. The authors and their studies are the Small Business Council’s U.S. Business Policy Index, the Beacon Hill Institute’s State Competitiveness Report, the Tax Foundation’s State Business Tax Climate, the American Legislative Exchange Council’s Rich States, Poor States: the ALEC Laffer Economic Competitiveness Index, Ernst & Young’s COST Competitiveness
of State and Local Business Taxes on New Investment, and KMPG and the Tax Foundation’s Location
Matters.
The last two, Rich States, Poor States and Location Matters, “allow for more complexity and nuance because they acknowledge that different companies and facilities vary greatly in how they interact with tax codes and they are aimed at measuring how tax systems impact plant expansions or relocations,” Fisher writes.
He adds, “Unfortunately, both models have serious flaws and fail to take full advantage of the methodology. COST’s model excludes pass-through entities such as S-corporations or LLCs [limited liability companies], very common to small-business forms. And even though it models five different kinds of facilities and three kinds of taxes, it hides these disaggregated results and provides only two blended numbers per state. In a huge omission, it fails to account for tax incentives, even though such subsidies can greatly reduce tax liabilities and thereby affect investment returns.”
With the KPMG-Tax Foundation report, the authors modeled seven theoretical companies, Fisher says. They assumed six of the seven had payroll and property in only one state but sales in all 50 according to the sizes of the economies of all 50, “then admit such a scenario is unrealistic” before he lists their other shortcomings.
“Held against each other, the COST and Tax Foundation numbers show many contradictions,” Fisher writes. “Comparing the five most comparable tax-rate estimates shows an average difference of 57% per state.”
As LeRoy notes, those were the two most credible studies. “ ‘Business climate’ studies must be viewed for what they are,” he writes, “attempts by corporate sponsors to justify their demands for lower taxes and to gain public-sector help suppressing wages.”
An associate professor of economics at Youngstown State University, A.J. Sumell, who reviewed “Grading Places” for this article, says the consensus among economists is, “Taxes and tax incentives play a marginal role” when companies decide whether to stay, where they’ll expand and where they’ll relocate.
“Firms consider long-term factors,” he said, such as “quality of the workforce, cost of land, and whether [a site is] near major transportation hubs. … The quality of the infrastructure is important,” he said.
While companies take them into account, Sumell said, “Taxes are not that important.”
When states and municipalities learn a major company is interested in their region, they often get into bidding wars with each other to persuade that company to locate within their boundaries, Sumell notes. They try to make it even more attractive to locate in abandoned inner cities and brownfields, for example, than elsewhere within their boundaries.
Angelos Angelou, an economics consultant and former vice president of the Greater Austin (Texas) Chamber of Commerce, finds that job growth is more closely tied to rates of entrepreneurship and retention of young professionals than tax incentives. States with aging populations and higher taxes on corporations find themselves in positions of offering more generous incentives than states with younger populations and lower taxes.
Economic development literature abounds with accounts of how states and regions all but gave away the store to attract a new plant or factory.
In recent newsletters, LeRoy reports how Mississippi offered Nissan $290,000 per job over the life of the subsidies it granted the Japanese automaker, “three times the previously reported number,” he writes. He relied on a study by the United Auto Workers union. Mississippi has extended more than $1.3 billion in incentives to Nissan, LeRoy reports.
Nissan called the UAW study a “cynical” attempt to deflect attention away from the union’s inability to organize workers at its plant in Canton, Miss.
To keep Marathon Oil in Ohio, the state extended $72 million in tax incentives in 2011, The Economist magazine reports.
“I’m not saying all subsidies offered are bad,” Sumell said. “I’m saying that’s not a company’s main focus. Worker training is more important [to a company] than reduced taxes, for example.”
Those who make such decisions look at quality-of-life issues such as proximity to universities, professional sports teams, museums, symphony orchestras, crime levels, parks and golf courses. They look at the levels of education attained by the workforce from whom they’ll hire. “Decisions are based on more than profits,” Sumell says.
Fisher is critical of the U.S. Business Policy Index because it “consists of 46 measures it describes as ‘government-imposed or government-related costs impacting small businesses and entrepreneurs, [that is,] how much a state taxes or regulates business.”
Ignored are “state spending on infrastructure, the quality of the education system, small-business development centers or entrepreneurship programs at public universities, technology transfer or business extension programs, business-university partnerships, small-business incubators [and] state venture capital funding.”
Ohio ranked 18th on this index, Pennsylvania 24th.
Fisher concludes, “The USBPI is at best a crude index of the level of progressive taxes in a state and little more. … It leaves out most of the factors that have an impact on small-business survival and entrepreneurship.”
The Beacon Hill Institute’s State Competitiveness Report, is built on 45 variables organized into eight subindexes, Fisher reports. (The institute describes itself as the “research arm of the Department of Economics at Suffolk University.”)
Fisher is critical of this report because its authors confuse cause and effect. “The most serious problem is that they mix causal and outcome variables indiscriminately,” he writes. “A number of BHI’s variables are measures of the outcomes or components of economic growth, not causes of it, such as the share of adults in the labor force, [state] budget surpluses, initial public offerings, exports and firm births.”
Government surpluses, he notes, are a result of, not a cause of robust income and revenue growth, and a budget surplus can be a drag on economic growth.
Another defect in the Beacon Hill study, Fisher says, “is very incomplete data. Many of the variables are missing for many of the states [and …] BHI does not explain how it handles the missing data.”
Ohio ranked 45th in this report, Pennsylvania 39th.
The Tax Foundation’s State Business Tax Climate Index, Fisher writes, “stirs together no less than 118 features of the tax law[s of the states] and produces out of that a stew a single arbitrary index number that turns out to bear very little relationship to what businesses actually pay.”
The less businesses pay in taxes, the more favorable the climate, according to the Tax Foundation. Quoting the foundation, “Most importantly, taxes diminish profits. … A state with lower tax costs will be more attractive to business investment.”
The level of taxes and business climate are two entirely different things, Fisher says, but the Tax Foundation treats them as identical.
“A state with no corporate income tax must levy other taxes to finance government,” Fisher observes. That could result in higher property taxes which, in turn, penalizes a capital-intensive enterprise.
The Tax Foundation index consists of five components: corporate income taxes (weighted 20.1%), individual income taxes (33.1%), sales taxes (21.5%), unemployment insurance (11.4%) and property taxes (14%).
Fisher quarrels with the weights assigned because they change annually. “This makes it difficult to sort out whether a state’s change in rank was due to a policy change or just changes in the weights given the five components,” he explains.
The Tax Foundation index “is all about penalizing states with progressive tax structures,” he says. Because individual income taxes are the only progressive component in a state’s tax system (if it has a graduated tax), such states suffer more.
Ohio ranked 39th, Pennsylvania 19th in the Tax Foundation’s competiveness index.
In the two studies deemed to have more validity, KPMG and Ernst & Young, the Buckeye State ranked third-best in both albeit Ohio ranked fifth-best for mature firms in the KPMG study.
First published in the June print ediiton of The Business Journal.
Copyright 2013 The Business Journal, Youngstown, Ohio.
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