Saturday, April 21, 2012

Is Governor Walker Right? Does Keeping State Taxes Low Increase Entrepreneurship?

Governor Scott Walker, who wants to run Wisconsin's government more like businesses operate, which generally seems like a good idea. (Particularly since businesses usually don't publicly denigrate their employees.)

A consistent theme of the Walker administration has been that the effort being made to balance the budget in Wisconsin under Act 10, by cutting wages and benefits for public workers, will induce significant new job creation by inducing "job-creators" to relocate to Wisconsin from higher tax states, and by encouraging existing Wisconsinites to take the risks attendant to starting up new businesses. This theme made me wonder if there are any available data that support or debunk this notion that low state taxes equal better job opportunities within a state.

I previously posted about the Coincident Index of the Philadelphia Federal Reserve Bank back in March, in a post entitled "Ouch! Governor Walker Touts Fed Data. He Shouldn't Have Gone There."

The Fed data was being hyped by the Walker administration in March in ways that made it clear that the data either wasn't understood by the governor's staff, or that they decided to simply misrepresent it.  The Philly Fed's Coincident Index had Wisconsin, over the last twelve months of the Walker Adminstration, doing more poorly in economic development than every state in the country other than Alaska and Montana. 

It turns out that there are some interesting data available on the internet on how states are doing in creating jobs through start-up businesses.  One of the sources of data is the Kauffman Index of Entrepreneurial Activity, an index that is financially supported by the Ewing Marion Kauffman Foundation, and is a well respected business index.  An economist at the University of California - Santa Cruz, Robert W. Fairlie, is in charge of the index calculations using the Current Population Survey (CPS), sponsored jointly by the U.S. Census Bureau and the U.S. Bureau of Labor Statistics (BLS).  The CPS is a monthly survey conducted by the Census Bureau during which some 60,000 occupied households in all 50 states and the District of Columbia are surveyed by Census workers.  The survey is extensive, and includes questions about the number of hours worked for a new business that is in its first month of operation.

The Kauffman Index records new business owners in their first month of significant business activity, and provides the earliest documentation of start-up business development across the United States. The percentage of the adult, non-business-owner population that starts a business each month is measured.  The data is broken down by states, to permit a comparison of how Wisconsin compares with Illinois in start-ups, for example. 

A Kauffman Entrepreneurial Index ("KEI") of .34% means that .34% (a third of one percent) of all adult residents of a state started a business per month in the year of data. Thus if one state has a KEI of ,34%, and a second state a KEI of 17%, the first state is creating new businesses at a rate that is twice that of the second one.

To test the key hypothesis of the Walker Administration that lower tax burden leads to greater entrepreneurship, I compared (A) the annual total state and local tax burden of selected states, as a percentage of total Gross State Product (GSP) (the total sum of all value added by industries within the state, which serves as a counterpart to the national gross domestic product (GDP)) and (B) the Kauffman Entrepreneurship Index of the same states, over the period 2004-2011.  The states I chose were the seven states in the Upper Midwest that seemed to be reasonably similar in terms of economic activity, provision of government services, per capita income and general demographics.  The total tax burden data comes from the Council on State Taxation (COST), and is put together by the national accounting firm of Ernst & Young.  A total tax burden of 6.0% is 50 percent higher than a total tax burden of 4.0%.

Here is the chart of the data broken down in two four year periods.  The COST data on 2011 total state and local tax burden isn't yet available. 


It is difficult to see any correlation between lower tax burden and higher KEI from this data.
However, let's try another way, by looking at the total of the averages for each state over the eight year period:


This average data from 2004-2011 suggests that there is no real discernible connection between marginally higher tax burden and reduced new business start-ups.  Over the eight years, Indiana's tax burden was a full one-half percent lower than the national average, but Indiana significantly lagged the national KEI by almost 25%.  While Illinois' business tax burden (as measured as a percentage of GSP) exceeded its neighbors by as much as six-tenths of a percent (Indiana) Illinois and Indiana had identical rates of start-up businesses, and all states had generally similar rates of new business start ups over the eight year period.

The other conclusion is that the variation in tax burden seems so miniscule in the grand scheme of things, that I can't envision it being the basis for any business owner moving from one of these seven states to another to start up a business.

All this suggests to me that the impact of the level of state and federal tax burden on entrepreneurial risk-taking is over-blown, and probably pales in comparison with other factors like general economic vibrancy, efficient transportation infrastructure, per capita income (and concomitant discretionary disposable income), strength of educational systems (particularly worker-training programs and university research centers), crime rates, insurance rates, access to cost-effective professional services, rates of home ownership, access to high-speed internet, and a host of other indicators of economic health.

One other aspect of the KEI data should be considered.  The data is current through the end of 2011, the first year of the Walker administration.  The KEI for Governor Walker's first year was .23%.   The KEI average of the prior seven years of the Doyle administration (2002 and 2003 KEI state-by-state data was not available) was higher, at .26%.  

Today's Wisconsin State Journal had an article on state money being set aside at a time of severe cutbacks in order to supply bonuses and pay raises to high-performing state employees.  Here is part of the article:
The Republican governor wasn't available for comment Friday. His spokesman, Cullen Werwie, referred questions to Walker's top aide, Department of Administration Secretary Mike Huebsch, who said the governor established the program because he felt it was important to mirror the private sector and provide rewards for outstanding work.  (Emphasis supplied.)
Part of "mirroring the private sector" in the operation of state government is by using clearly defined metrics to measure the performance of a state administration.  Whether measured by the principal metric the governor established, the creation of 250,000 new private sector jobs in four years, or by the Philly Fed Coincident Index, or the Kauffman Entrepreneurial Index, or the massive loss of educators in public schools, the metrics of this administration are sub-standard.


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