Bast: Building a Better Business Climate

The latest numbers on unemployment show the nation is still in the grips of the deepest economic recession since the Great Depression. Economists are predicting a “double dip” recession, meaning things may get worse before they get better.

As voters and active citizens, what should we be asking elected officials to do in order to restore prosperity to our nation and to our particular cities and states? I recently reviewed an extensive body of research on business climates – the panoply of government policies that aid or hinder economic growth – for a new installment in Heartland’s Legislative Principles series. Here is what I found.

1. Keep total tax burden low.

The most important thing elected officials can do to restore economic growth is to cut taxes. Economists estimate that for every 1 percent decrease in taxes, we would see a 0.3 percent increase in economic activity, and a similar opposite effect for higher taxes.

In 2001, Richard Vedder, a distinguished professor of economics at Ohio University, examined several dozen measures of taxes and spending in the years 1957, 1977, and 1997. He reported, “In every single case, without exception, the results are consistent: High or rising taxes are associated with lower amounts of economic growth. The use of more sophisticated statistical models produces the same sort of result: higher taxes, lower growth.”

“Taxes are an important cost to business, as important as the cost of labor and raw materials,” Tax Foundation President Scott Hodge told Budget & Tax News in 2006. “Nearly all of the best states raise sufficient revenue without imposing at least one of the three major state taxes: sales taxes, personal income taxes, and corporate income taxes.”

2. Keep taxes on businesses low.

It’s an old saw, but true: Businesses don’t pay taxes, people do. The taxes businesses pay are passed on to customers in higher prices, taken out of the pay of workers, removed from the returns earned by investors, or taken from the income of the business’s owner. With a top rate of 35 percent, American companies pay one of the highest corporate tax rates of any of the industrialized countries.

Few people understand how many taxes businesses have to pay and how those taxes affect their decisions. Small businesses typically pay capital gains taxes, personal income taxes (more than 90 percent of businesses file taxes as individuals, and therefore pay personal income taxes rather than corporate income taxes), unemployment taxes, death taxes, sales taxes, and property taxes. It is this total tax burden that must be kept in mind, not one or two specific tax rates.

3. Avoid corporate welfare.

Cutting taxes on businesses is good, but selectively lowering taxes on some businesses or offering them subsidies is not. Even the wisest public officials cannot allocate resources as fairly or effectively as capital markets, which efficiently set the prices of debt or equity securities issued by companies.

Public officials try to pick winners and avoid losers, but experience shows they seldom succeed. A 2001 review of more than 300 scholarly papers on economic development programs found, “studies of specific taxes are split over whether incentives are effective, although most report negative results.”

4. Remove privileges enjoyed by labor unions.

Through their power to strike and disrupt a business’s activities, unions raise wages in some industries above levels that would otherwise prevail. In an age where labor and capital are highly mobile, raising wages significantly above levels justified by workers’ productivity can damage both the business and its workers.

Many states extend privileges to unions that make it easier for them to organize, threaten to strike, or steer government contracts to union shops. Removing those privileges can improve a state’s business climate by freeing businesses and workers from unwanted unions and allowing less-expensive nonunion shops to bid on government projects.

5. Lower minimum wages.

Governments cannot require businesses to pay more than a worker’s productivity is worth. When they try, by enforcing legal minimum wage laws, young people and people with few skills lose their jobs. Entry-level jobs don’t pay well, but they are vitally important to helping people get their start in the job market by teaching important skills and creating job histories that subsequent employers can rely on.

Economic research clearly shows high minimum wages have a negative effect on job creation. With the Great Recession driving unemployment rates to double digits in many cities, high minimum wages are creating a climate where young people and others entering the workforce can’t get started on their career ladders. The negative effects can last their entire lifetimes.

6. Reduce workers’ compensation costs.

Workers’ compensation statutes are established to ensure that workers injured or disabled on the job are provided with fixed monetary awards, eliminating in theory the need for litigation. The deal was a “win-win” at first, but over time it has resulted in rapidly increasing premiums. Most employers must pay high premiums to subsidize a few industries with poor safety records, medical benefits are more expensive than those provided by other types of health insurance, and workers tend to report injuries that are not work-related.

Reforms that would make workers’ compensation less expensive include adjusting premiums according to the experience of individual firms rather than occupational or industry risk ratings, combining employee health plans and workers’ compensation medical coverage, and creating Workers’ Compensation Accounts (WCAs) that would give workers more flexibility in how to spend the money that is allocated for their benefit.

7. Keep housing affordable.

Affordable housing is an important and often over-looked part of a good business climate. Texas is leading the nation in job creation while California is trailing it in no small part because the cost of housing in Texas never shot up the way it did in California.

The problems in the mortgage industry arose at least partly due to regulatory policies that unnecessarily raised costs, limited competition, and exposed taxpayers to risk. Restoring order to housing markets requires adopting a “no bail outs” policy; privatizing Fannie Mae, Freddie Mac, and the Federal Home Loan Bank system; and loosening or repealing zoning ordinances, building codes, and smart-growth policies.

8. Reduce the burden of regulations.

Americans for Tax Reform Foundation estimates the cost of regulations at all levels in the U.S. to be more than $1.5 trillion per year. Economists estimate that every $15 million in additional regulatory compliance costs causes one premature death due to lost income.

Economist James L. Johnston (a founding member of Heartland’s board of directors) observes that regulation is appropriate only when three conditions are present: the product or service is subject to substantial shifts in supply and demand, supply reliability cannot be achieved through precautionary stocks or other market techniques, and substantial social costs are incurred when supplies are interrupted. In those situations, the intended effect of regulation is to improve the stability of supply by encouraging extra investment in reliability.

We could save hundreds of billions of dollars a year simply by asking if current and proposed regulations are justified by Johnston’s test, and repealing those that flunk the test.

9. Discourage lawsuit abuse.

A state’s tort system – the laws governing questions of liability in the event of injury – helps protect the safety of the state’s residents and visitors, while its cost influences the competitiveness of businesses based inside its borders. A good tort system compensates victims fully, in a timely fashion, and without excessive costs to either the parties or to taxpayers. A bad tort system produces unpredictable awards, requires months or years of litigation before awards are made, and consumes a significant portion of monies in fees to lawyers and court costs.

Unfortunately, the U.S. tort system has become increasingly expensive and dysfunctional over time. Reforms that have proven to be the most beneficial in states where they have been adopted include limiting non-economic tort damages, capping or banning punitive damages, limiting contingent fees, adopting a “loser pays” policy, and enacting stiffer sanctions on frivolous claims.

10. Attract members of the creative class.

A final component of a good business climate is adopting policies that make cities and communities attractive to scientists, engineers, entrepreneurs, and other members of the so-called “creative class.” These individuals are sought after by companies, with the result that businesses will move to cities and regions where such individuals congregate.

Members of the creative class are younger than the average worker and seek cities with amenities that suit their lifestyles. They change jobs frequently and consequently prefer to live in cities with lots of job opportunities to avoid having to relocate. Creative people spend more time on outdoor recreation and view their cities the way tourists do, as a collection of places to visit to have fun.

Cities and states that keep these preferences in mind can avoid wasting millions of dollars on “economic development” schemes that target the wrong people or attempt to draw them to the wrong places.

Conclusion

These ten policies are backed by extensive research and common sense. Policymakers who are sincere about creating jobs and ending economic suffering can make a real difference by adopting them as their agenda.

Joseph L. Bast (jbast@heartland.org) is president of The Heartland Institute.