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Why Don’t Business Climate Indexes Matter?

It’s become a part-time hobby of mine to debunk the various “business climate” indexes, showing that they have little to do with actual economic health and performance (see here, here, here, here, here, here and here). These indexes typically operate in an evidence free zone, invariably tell West Virginia that we need to cut taxes, reduce government, and weaken labor laws, despite no proof that any of these actions will help.

Well now, Good Jobs First has released a report, written by economist Dr. Peter Fisher, looking at a number of these “business climate” studies, and concluded that these rankings have no value, and are full of “profound and elementary errors.” The report, “Grading Places: What Do the Business Climate Rankings Really Tell Us?” shows that these studies are no more than “politicized grab-bags of data” with no predictive value and should not be used to inform public policy.

The report looks at the Beacon Hill Institute’s State Competitiveness Report, the Small Business and Entrepreneurship Council’s U.S. Business Policy Index; the Tax Foundation’s State Business Tax Climate Index; and the American Legislative Exchange Council’s Rich States, Poor States: the ALEC-Laffer Economic Competitiveness Index. The report also takes a look at two tax burden studies: the Council on State Taxation’s Competitiveness of State and Local Business Taxes on New Investment, prepared by the accounting firm Ernst & Young, and the Tax Foundation’s Location Matters, prepared with the accounting firm KPMG.

None of the reports shows any predictive value about economic growth, as several of my previous blog posts show, and their findings are highly inconsistent with one another, as the cover of the report shows. They also produce rankings that have little to do with actual taxes paid in one state versus another. The Good Jobs First report also finds that they often include factors that are the effects of economic growth, not the cause, or other factors that have been proven to have no effect on economic growth. Instead, their rankings better reflect the case for the policy positions advocated by the organization sponsoring the study, rather than policies that do create economic growth.

The Good Jobs First Report identifies major issues with each of the examined business climate indexes that explain why they are basically useless. Entrepreneurship Council’s U.S. Business Policy Index is made up from 46 variables, including six on health care regulation, 22 on taxes, and seven on government services. But when broken down, only 12 distinguish one state from another; the other 34 make no difference. And the index has no correlation with other measures of state innovation and entrepreneurship, like those from the Information Technology and Innovation Foundation.

The Beacon Hill Institute’s State Competitiveness Report combines 45 variables, but many of them confuse cause and effect, like labor participation rates, firm births, initial public offerings, exports, and public-budget surpluses, all of which are the result of a strong economy, not the cause.

The Tax Foundation’s State Business Tax Climate combines 35 tax variables, but their rankings favor regressivity over actual tax burden. Of the report’s top 10 states, only one actually ranks among the 10 states with the lowest share of state GDP going to business taxes. 

The American Legislative Exchange Council’s Rich States, Poor States: The ALEC-Laffer Economic Competitiveness Index, completely fails to predict job creation, GDP growth, state and local revenue growth, or rising personal incomes, despite claiming to do exactly that.

Finally, the reports bear no relation to one another. 22 states can brag that they have a top 10 business climate, according to at least one of the rankings, while 24 states can complain about being in the bottom 10.

The major problem with these rankings is their belief that state and local business taxes are the driving force behind economic development, when the actual research shows  taxes are such a small share of business costs that they have little effect on investment decisions. All of the rankings ignore the role of state and local governments in supporting economic growth through investments in education, job training, infrastructure, health, and public safety. Instead, they favor wage suppression, a small public sector, and, above all else, regressive taxation as a result of low business taxes.

As a result, these rankings encourage a single-minded pursuit of business tax cuts as key economic development policy, and undermine the public structures that can lead to real economic growth and prosperity. 

(Correction: A passage from this post regarding the Beacon Hill Index was corrected after Good Jobs First reported a problem with the index in its findings. See here.

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