Dean Barber

Business Climate and the Cost of Regulation

In Corporate Site Selection and Economic Development on February 5, 2017 at 6:35 am

It is a treacherous thing, this ranking of states by business climate. By and large, I put little stock into it, although I recently congratulated some economic developers from Utah for a No. 1 ranking by a magazine.

Heck, I am not above trying to be nice on occasion.

If you haven’t noticed, business climate rankings have become somewhat of a cottage industry. I don’t know how many there are any more. The truth is they are inherently flawed and even misleading, because they use different approaches and thereby come up with widely different results.

George Mason’s Mercatus Center ranked Alaska’s business climate No. 1, while both CNBC and the Tax Foundation put it 47th. CNBC ranked Minnesota first, but the Tax Foundation ranked it 47th. George Mason ranked Ohio seventh, while the Tax Foundation listed it at 44th.

In an attempt to make some sense of all this, Dick Heupel, director at the Center for Community Economic Development at Ball State University, a smart fellow despite being an academic, developed an average index of state business climate rankings. Helping him was an undergraduate student, Rosemary Kaiser.

Now I have not studied the report at great length, but he nailed it when he wrote this:

“What is clear is that little sense can be made of state business climate rankings from any single source, except to cite one when it supports a state’s good image and ignore it when it does not.”

Good job, professor.

Why Business Climate Matters

Business climate is important to companies because it affects their bottom line. For that reason, it is a key consideration to the corporate site selection process (finding a new location from which to operate) and should be of prime interest to economic developers who are charged with growing businesses in their communities.

Business climate can best be thought of as the general economic environment of a place. Much of it boils down to the attitude of government officials have toward business activity and the tax and regulatory policies they put in place. Leave it to say, not all places are created equal in that regard.

There’s an old saying, “God made man and Samuel Colt made them equal.” My consultant spin: “People made government and lawyers  made a killing.”

Way to Go, Joe

We know that government can and often does foul the business climate of a place by enacting burdensome taxes and regulations. Thankfully, government can also reverse policies and undo the damage done. We have elections for that, but some places just seem to stay stuck.

My friend, Joe Vranich, a fellow site selection consultant based in Irvine, California, has made it his calling of documenting and reporting the size and scope of companies leaving California for other states.

Vranich, the principal of Spectrum Location Solutions, concluded in a study that 9,000 companies left the Golden State — either completely or in part — between 2008 and 2015 – due in large part to the tax and regulatory climate there.

I even got in on the act and wrote two back-to-back blogs (probably overreach on my part) back in 2014 on the subject, Escape from California and This Ain’t Rocket Surgery.

In a guest editorial in a California business publication last week, Vranich wrote, “As a consultant who helps companies find business-friendly locations in which to locate, I encourage clients to keep a low profile. Otherwise, they will be hammered without mercy from an uninformed public and sometimes from public officials who know little about what it takes to run a business.”

Joe has been roundly criticized for his work and ignored by state lawmakers, too. Still, I think he deserves great credit. Way to go, Joe.

Trump’s Executive Orders   

Also last week, in keeping with what has been a fast and furious pace, President Trump signed executive orders consistent with his long-stated beliefs that overregulation is hampering America’s economic growth and plans for decreasing regulation.

On Friday, the president ordered a review of the laws and regulations that govern the 2010 financial overhaul law, known as Dodd-Frank. The complicated legislation touches nearly every aspect of the way banks operate and includes hundreds of rules, some of which have yet to be implemented.

Trump has described Dodd-Frank as “a disaster,” asserting that it was “almost impossible now to start a small business and it’s virtually impossible to expand your existing business because of regulations.”

On Monday, the president signed a separate executive order requiring federal agencies to cut two existing regulations for every new regulation they implement.

“If there’s a new regulation, they have to knock out two. But it goes far beyond that, we’re cutting regulations massively for small business and for large business,” Trump said during the signing of the order, while surrounded by small-business leaders.

Might There Be Middle Ground?

Not surprisingly, consumer groups and environmentalists have criticized the push to roll back regulations, arguing that it would remove important protections for the public.

I believe many of those protections are important and should remain in place, particularly when it comes to the health and safety. (I want to get on a commercial aircraft that is regularly inspected; I want that doctor poking, prodding and cutting on me to be accredited.)

But I also believe that our business community is hamstrung by overregulation. And I think even some consumer groups and environmentalists might privately even concede that. (I’m always looking for middle ground.)

The U.S. Business Administration implicitly acknowledges the problem with its Office of Advocacy, designed to help “relieve small business of regulatory burdens.” In 2015, the pages of the Federal Register grew by 81,611 pages covering 3,378 final rules and regulations, nearly 600 of which directly impact small businesses.

The Harm and the Cost

So how does too much regulation do harm? There is a cost to compliance, although most of these costs are “hidden.” They will not show up on a company’s books as a regulatory expense. They are the costs of new and misallocated labor, materials purchased, paperwork, and legal costs.

Those costs are disproportionately higher for the 26 million small business owners in this country.

Economists W. Mark Crain and Nicole V. Crain of Lafayette College contend that government regulations create “inefficiencies in the structure of American enterprises;” adversely affecting “the international competitiveness of domestically produced American products and services;” and leading to “the relocation of production facilities to less regulated countries.”

Manufacturers Hit Harder

The National Association of Manufacturers (NAM) in 2014 estimated an annual regulatory cost of $2 trillion. A more recent study, Bentley Coffey, Patrick A. McLaughlin, and Pietro Peretto of the Mercatus Center places the total cost of regulation at $4 trillion each year.

The NAM report that showed the extent to which manufacturers bear a disproportionate share of the regulatory burden, and that burden is heaviest on small manufacturers because their compliance costs are often not affected by economies of scale.

The analysis found that the average U.S. company pays $9,991 per employee per year to comply with federal regulations. The average U.S. manufacturer pays nearly double that amount—$19,564 per employee per year. Small manufacturers, or those with fewer than 50 employees, incur regulatory costs of $34,671 per employee per year.

Government Created Problems

In its Small Business Problems and Priorities Survey and 2016 report, the National Federation of Independent Business (NFIB) found that nine of the top 10 business challenges faced by small businesses are directly associated with government. They are:

“Cost of Health Insurance,” “Unreasonable Government Regulations,” “Federal Taxes on Business Income,” “Uncertainty over Economic Conditions,” “Tax Complexity,” “Uncertainty over Government Actions,” “Frequent Changes in Federal Tax Laws and Rules,” “Property Taxes (real, inventory or personal property),” “State Taxes on Business Income,” and “Locating Qualified Employees.”

“Many Americans are frustrated by the federal government’s failure to solve problems. Small business owners are frustrated by the problems that the federal government creates,” said NFIB President and CEO Juanita Duggan, who met with President Trump in the White House last week.

“All of the top problems for small businesses relate directly to excessive federal regulation and taxation.” (Actually, the 10th, locating qualified employees, did not.)

Not Just the Feds

It should be noted that excessive regulation and taxation is not a problem solely relegated to the federal government, but extends to government on the state and local level. Hence, the business climate rankings of states.

Said NFIB California State Executive Director Tom Scott in a prepared statement, “Compared to the national trend, California paints an even uglier picture for small businesses. Three problems California small business owners rank much higher than those in other areas of the United States are family/sick leave mandates; minimum wage laws; and hiring/firing employment regulations.”

NFIB’s survey might be a bit slanted. The respondents tend to be disproportionately Republican. I get that. Still, this group represents a large constituency that creates jobs. (Small businesses account for 64 percent of the net new private sector jobs.)

Business climate is not only not only a top concern for resident businesses in any given place, but of primary interest to companies when considering new locations. As a site selection consultant, I want to steer companies to those places with better business environments. Read last week’s blog People, Infrastructure and Cost.

Uncertainty Curbs Investment

Taxes, permitting, and regulation all speak to a community’s business climate. And with a U.S. economy that remains sluggish (2 percent GDP growth for how many years now?), companies are naturally cautious, as well they should be.

Adding more regulations only creates more uncertainty. Companies will delay buying capital equipment or adding workers in certain places often because of the onerous regulatory environment of those places. And again, in a corporate site selection search, we want to bypass those places.

My advice to elected officials and economic developers: Don’t be one of those places.

Rather, foster a stable and friendly business climate, with reasonable regulations that are well thought out, one-stop-shop permitting, and lower taxes. Do all that and your community will rank high with me.

I’ll see you down the road.

Dean Barber is the president/CEO of Barber Business Advisors, LLC, a location advisory and economic development consulting firm based in Dallas. BBA helps companies and communities. Mr. Barber is available as a keynotes speaker and can be reached at dbarber@barberadvisors.com or at 972-890-3733.

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  1. Good article today Dean. I plan to spend some time with the Ball State Study- I always get a little nervous when I get close to an article using “mean” and “Median” in their findings as it is a bit too close to a statistics class I remember.

    In regard to rankings by site selection magazines, I find the results are skewed by the number of dollars spent on advertising in the magazine.

    Take care- I hope to see you soon.
    Charlie

    Charles L. Smith, CEcD
    Executive Director
    Main Line: 903-572-6602
    http://www.mpedc.org

  2. You are exactly right, Charlie. I should have said that. Come see me. Take care.

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