Study Ranks States by Economic Freedom

Published July 1, 2004

A new report issued by the Pacific Research Institute for Public Policy (PRI) ranks Connecticut, California, and New York lowest in terms of “economic freedom”–how friendly or unfriendly state governments are toward free enterprise. Kansas, Colorado, and Virginia rank highest in the report, which was featured in Forbes magazine’s May 2004 “Best Places” issue.

“Where should you locate new businesses and subsidiaries?” asked Lawrence J. McQuillan, director of business and economic studies at PRI, in an article for Forbes. “In states with the fewest regulatory body blocks and fiscal obstacles.”

PRI, an independent nonprofit research organization based in San Francisco, teamed up with economists Ying Huang and Robert E. McCormick of Clemson University to create the “U.S. Economic Freedom Index.”

“In coming up with our ratings we evaluated 143 variables for each state, using the most recent data,” explained McQuillan. “This snapshot includes tax rates, state spending, occupational licensing, environmental regulations, income redistribution, right-to-work and prevailing-wage laws, tort laws, and the number of government agencies. These we grouped into five sectors–fiscal, regulatory, judicial, size of government, and social welfare.

“For each of the 143 variables we ranked states from 1 (most free) to 50 (least free), calculated an average sector ranking, and then weighted them to get an overall score,” continued McQuillan. “Welfare, fiscal, and regulatory matters counted about equally; government size and judicial ratings counted for less.”

California at “Bottom of the Barrel”
“California ranks at or near the bottom in almost every measure of economic freedom: 48 in welfare spending/income redistribution, 48 in fiscal responsibility, and last, 50th, in regulatory burdens,” said McQuillan. “As a result, California is at the bottom of the barrel in economic freedom,” he said.

“Governor Schwarzenegger must focus his energies, as he has, on rebuilding the state’s business climate through low taxes, less regulation, and common-sense reform of the rules and organization of California’s government,” continued McQuillan. “There is no better model to follow than Colorado–ranked #2 in economic freedom–which has a constitutional limit on tax increases.”

Only New York ranks worse than California. The Empire State fares especially poorly on government size and welfare spending/income redistribution, where it ranks 50th. It ranks 47th on fiscal, 42nd on regulatory, and 45th on judicial matters. “New York is consistently bad,” summarized McQuillan.

Kansas, by contrast, ranks best on the PRI index due largely to its “respect for property rights.” Kansas also “engages in less income redistribution and attracts less tort litigation than most states.” The Kansas legislature is now considering innovative bills exempting custom software from sales taxes and eliminating the state franchise tax for most businesses–a “serenade to entrepreneurial ears,” noted McQuillan.

Kansas risks losing its top ranking, however, once the dust settles on the state’s current battle over taxes and education finance.

Colorado, “with the fewest regulatory barriers,” according to McQuillan, ranks second overall. The state also ranks high in the fiscal sector of the economic index, thanks to its constitutional tax and expenditure limitation–the TABOR (Taxpayers’ Bill of Rights) adopted in 1992. Virginia, which shows “restraint in income redistribution” is currently third, but may fall in future indices depending on the impact of its recent tax hike. (See “Virginia Passes $1.6 Billion Tax Hike; Voters May Not Forget,”Budget & Tax News, June 2004.)

In general, the South “does not live up to its image as a business-friendly region,” said McQuillan. The states most hospitable to free enterprise tend to be in the Great Plains and Rockies. The most “punitive policy environments” are in California, Connecticut, New York, and Rhode Island. (See accompanying map.)

State Ranks by Economic Freedom

John Skorburg is managing editor of Budget & Tax News. His email address is [email protected].

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