Unemployment is high across the U.S., but some states are better than others at creating jobs. Texas Governor Rick Perry cast a spotlight on this when he entered the presidential race. His fast-growing state accounts for as much as half of all net U.S. jobs since mid-2009. Texas is part of a broader pattern, from which all states can learn.
Research shows that states keeping costs low for business have enjoyed better job growth during the past couple of decades. The low costs appear to be more important than other advantages often associated with higher spending, including infrastructure and an appealing quality of life.
Those findings emerge in a recent paper by Jed Kolko and Marisol Cuellar Mejia of the Public Policy Institute of California, along with David Neumark of the University of California at Irvine. The researchers compared states by digging into almost a dozen indexes that rank business-climate attractiveness.
These indexes are only rough guides to policy, and vary in the importance they place on factors such as education, taxes and regulation. Comparing them, though, does highlight important differences across states.
Five indexes have much in common, broadly capturing the cost of doing business, including taxes, regulations and the courts. States ranking highly on one such index tend to score well on other indexes in this group. Five other indexes give less weight to the cost side. They instead emphasize factors ranging from policies trying to nurture startups to those leaning against income inequality.
Many states do well on some indexes and poorly on others. From 1992 to 2009, Texas had the fifth-best business climate, according to one cost-centered index, but scored third-worst on an index that didn’t emphasize costs. Massachusetts, on the other hand, ranked poorly on the cost indexes but was in the top four on several others.
The cost-based indexes do a better job of explaining employment growth. In one such ranking, controlling for other factors, the researchers found that the 10th-worst state could boost job growth by 0.3 percentage point a year if it could match the business climate of the 10th-best state. As the average employment growth for states was 1.15 percent a year, that is a huge potential gain.
Much of a state’s relative economic success is beyond the control of its lawmakers and governor, of course, especially in the short term. Nice weather attracts workers. Geography and history influence where industries are situated, and thus a state’s exposure to different types of boom and bust. High-tech zones in California were hit hard by the dot-com recession a decade ago. Energy-rich Texas suffered in the oil-and-gas bust of the 1980s.
More subtly, cultural and institutional factors that make a place ripe for growth tend to go hand-in-hand. The effects of specific policies can be hard to isolate.
Keeping Costs Down
Still, the low-cost pattern stands out. States scoring well on business-cost indexes have had faster growth in wages and economic output. Their faster rates of net employment growth include a better record of creating jobs by startups. This mechanism is important: Research by John Haltiwanger of the University of Maryland and co-authors at the Census Bureau has found that startups and other young companies disproportionately drive job creation.
By scrutinizing the cost-based indexes, the California researchers pinpointed which costs most affect job growth. An efficient corporate tax code, with a broad, simple base and low rates, helps a great deal. In particular, the relative absence of special tax credits, or different tax treatment for certain firms, seems crucial.
Some companies may move to states where their taxes are simple and low; others may find it easier to get started in those states. Both types of employer may create jobs faster in states where the tax code isn’t distorting their activity as much.
A Few Caveats
Before America’s governors rush to cut business taxes, they should consider a few caveats. First, a state may have higher taxes and spending (especially on programs that address unemployment and poverty) because its job growth is slow, not the other way around. The researchers cannot rule out that possibility. But they think they have limited this prospect by comparing across states over two decades, so short-term slumps that boost welfare spending shouldn’t be driving their findings.
Second, leaders must make trade-offs. Creating employment is a compelling goal, especially during a fierce slump. Still, spending money to counter poverty, or to make a state more pleasant to live in, is also important to voters in many places.
Even for states very different from Texas, however, lessons still hold. One is that the corporate tax code matters. If you’re going to tax more so you can spend more, you had better do it with simple taxes on a broad base, to mitigate the effect on job growth.
Another is that if states with high government spending are creating fewer jobs, they should look closely at where that money goes. A well-educated workforce is good, for example, but high education spending doesn’t automatically create one. Schools must be well run, and the money well spent.
Even with good policies, states can create only so much employment in a slumping national economy. But they can take steps to help themselves.
(Brian Barry is an economics professor and executive director of the Initiative on Global Markets at the University of Chicago Booth School of Business, and a contributor to Business Class. Opinions expressed are his own.)
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