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Why State Economic Policies Matter

States do compete with one another for business and for people. When we queried CEOs last January on their views of the best and worst states for business several patterns emerge.

In the sixth annual ranking (see Best and Worst States for Business 2010 story) the most highly rated 10 states, with perhaps one exception, are all red states – those with lower tax and regulatory burdens, lower costs of living and a friendlier attitude to business. By contrast, the states deemed worst for business: California, New York, Michigan, New Jersey and Massachusetts – regions that persistently adhere to their high-tax, high cost, anti business status – are the bluest of the blue states.

The real ticking time bomb for states is the swelling pension liability owed to government employees. According the Pew Research Center, $3.35 trillion has been promised to employees for retirement, but only $2.35 trillion is there. Even as roads and bridges fall into disrepair, politicians divert tax money to pay for salary and pension increases for government workers. In California, unfunded pension and health care liabilities for state workers topped $100 billion. In Michigan it’s $50 billion. New Jersey owes a staggering $90 billion. Not surprisingly these are states that have also experienced significant out migration. People are voting with their feet. The political elites in Sacramento and Albany have traditionally dismissed out-migration trends as marginal, but this misses the larger demographic adjustment – it’s the more dynamic and resourceful higher-income earners that leave and those with lower skills requiring public assistance who take their place. Economists and tax-policy analysts have long recognized the link between people’s behavior and higher relative marginal rates, especially in higher income brackets. And with the 2010 census in progress, that sucking sound you hear is the number of lost congressional seats due to reapportionment.

Tax progressivity, which tends to be more progressive in blue states, explains why tax receipts are more volatile in those states, something which makes them less attractive to business. When times are good it pushes more citizens into higher tax brackets thus inflating revenues. But when times are bad state revenues fall harder. Texas, which has been ranked consistently as the best state for business, is notable for its lack of a highly progressive income tax – perhaps because it doesn’t have one at all! Yet remarkably, its children get educated, its road and bridges are repaired and its hospitals function. Something to think about.


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