With the 2008 elections fast approaching, we soon will be hearing from our state and local politicians, in ever-increasing volume, how much they are doing to improve the business environment. Much of what you hear will simply take your breath away for both its predictability and its utter nonsense.
Am I being too hard on the political class? Well, maybe just a little, but you have to concede that they generally take credit for the good things that happen in the economy, while not only distancing themselves from the bad things but, in most cases, claiming that the bad economic news is a direct consequence of not adopting a particular plan or proposal advocated by that particular politician.
After a while, our body’s self-defense mechanisms simply take over and block out further discussion in order to protect our brain from serious long-term harm.
Still, as a senior executive charged with finding the best location for your company’s upcoming facility expansion, you have an obligation to examine closely the impact state and local politicians have on the region’s business climate, just as you would do your due diligence before launching operations in a foreign country.
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“State/local taxes and fees, in general, are a strong consideration in most site selection decisions.”
— Mary Faye LaFaver, Mid-Atlantic Director for Ernst & Young’ Business Incentives and Credits Services Practice
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“State/local taxes and fees, in general, are a strong consideration in most site selection decisions,” said Mary Faye LaFaver, Mid-Atlantic director for Ernst & Young’ Business Incentives and Credits Services Practice.
For many companies contemplating a facility expansion into a new state, that “legislative” due diligence often consists of just comparing income taxes — individual and corporate — and looking at the financial incentive programs each state offers businesses as an inducement to locate there.
While those are certainly important factors, they are just the tip of the iceberg when it comes to what you should be looking at. After all, unless you are contemplating a “plug-and-play” operation, like a call center, where you can pack up and leave quickly if you decide you’ve made a mistake, the facility expansion you are planning will represent a fairly long-term investment.
For that reason, you should also be looking at not only the current situation, but also the consequences of existing rates and programs five to 10 years into the future. Here are a few basic areas you should always consider when evaluating state government’s impact on the local business climate. NOTE: click here to view state-by-state results of the 2007 Legislative Quotient to see how each of the 50 states compared in each of the following financial management categories.
General Tax Bite. Every state requires revenue in order to operate and provide essential services, and they obtain that revenue through taxes and fees. The real issue is who pays and how much.
“State and local tax is one of the top five site selection factors on virtually every project we work on,” said Ulrich Schmidt, senior manager, Strategic Relocation & Expansion Services for KPMG LLP.
There are several simple metrics, in addition to just looking at tax rates, which will give you a good feel for the overall tax climate. The first goal is to focus on which type of tax your operation in that state would be most vulnerable to.
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“Income taxes for individuals are very important for employee transfers and the company as well. The employee evaluates the burden and/or benefit associated with the new location. The company calculates changes in payroll that may or may not be required to make sure that the employee remains whole.”
— Ed McCallum, Senior Principal, McCallum Sweeney Consulting
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“Income taxes are important for a headquarters location whenever there is a significant tax burden associated with sales that are allocated and apportioned to that state,” said Ed McCallum, senior principal for McCallum Sweeney Consulting, a Greenville, S.C.,-based site location firm whose list of recent headquarters clients include Boeing and Nissan. “Income taxes for individuals are very important for employee transfers and the company as well. The employee evaluates the burden and/or benefit associated with the new location. The company calculates changes in payroll that may or may not be required to make sure that the employee remains whole.”
In some cases, such as distribution facilities, the income tax rate is probably irrelevant, whereas the inventory tax rate becomes critical. In other cases, it may be property taxes or franchise taxes, or sales and excise taxes. Whatever your company’s particular tax “vulnerability” might be, it’s important to know not only the rates, but also how dependent the state government is on that particular source of revenue. That’s often a pretty good indicator of where the legislature is inclined to turn first when looking for more revenue.
Infrastructure Spending. When considering infrastructure spending, two areas to focus on are highways and education. Sure, there are others, but these are areas where states have a major funding responsibility that will impact your future work force, as well as your transportation infrastructure.
In the case of highways, they are also a prime candidate for deferred spending, where money is taken from the highway pot to spend on other budgetary priorities. The problem is not that this occurs, but rather that the more often legislatures succumb to this temptation, the easier it becomes the next time, and the next time after that.
Eventually, the effects of this neglect will build to a crisis point where the only solution will require massive amounts of tax dollars that, as a taxpaying business located in that state, will come from your corporate coffers.
Managing the Debt. Business, probably more than any other group, understands the importance, as well as the dangers, of debt. In fact, it’s hard to imagine running a business without the ability to receive or extend credit. It’s all in how you manage it.
But why should you be concerned about how a state government manages its debt? Because if you decide to locate a facility in that state, you effectively inherit responsibility for that debt, just as you would if your company bought out a competitor.
As a minimum, there are four rather simple numbers that you should look at: two near-term and two long-term.
On the near term, look at the percentage of the state budget used to service the debt (which ranges from 0.7 percent in Tennessee to 6.7 percent in Massachusetts), as well as the amount per capita needed to service the debt (which ranges from $30 in Tennessee to $437 in Massachusetts). These will give you a good feel for the debt’s impact on the current year’s budget.
To get a more long-range view of the impact of the state’s debt, look at the total debt as a percentage of total revenue for the current budget year (which ranges from 14.5 percent for Tennessee to 134.1 percent for Massachusetts), and the total debt per capita (which ranges from $599 in Tennessee to $8,750 in Massachusetts).
Spending on Itself. How much does the state spend on government administration? This is not a major factor, but it does provide another insight into how the government looks at its trust of spending the taxpayers’ money wisely.
The amounts range from Texas at 1.5 percent of the budget and $64 per capita to Delaware at 6.7 percent of budget and Alaska at $647 per capita.
Five-Year Trends. At least as important as looking at the current tax and spending numbers is to examine the trends in each tax and spending category during the past five years. That will give you a better feel for what the future will likely hold.
In this area, we looked at the five-year trends regarding the states’ reliance on corporate and individual income tax as a major source of state revenue, the tax bite per capita, how well the state has managed its debt and, lastly, how much the legislature spends on itself.
Right to Work Legislation. According to John Warden, executive vice president of The Walker Cos., an Atlanta-based real estate and site selection firm whose list of recent clients includes Columbia Sportswear, Dofasco Steel and AutoZone, right-to-work states from 1996 to 2006 experienced job growth of 14.4 percent, compared with 7.3 percent growth in non-right-to-work states. Currently, there are 22 states with right-to-work legislation.
What exactly does right-to-work mean? It simply means that union membership cannot be a required condition of employment for any worker in that state. However, it does not mean that unions are barred from organizing in that state. Still, the goal of this legislation clearly is to reduce union membership.
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“Union membership levels are lower in right-to-work states, which means management can be more responsive to fast-changing market conditions, and enjoy the kind of flexibility and freedom from union work rules required to be successful.”
— John Warden, executive vice president, The Walker Companies
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But why is this even an issue? After all, there is ample evidence to suggest that wage rates in non-union manufacturing plants are often higher than in neighboring union shops.
“Union membership levels are lower in right-to-work states, which means management can be more responsive to fast-changing market conditions, and enjoy the kind of flexibility and freedom from union work rules required to be successful,” Warden said.
As with all of the other factors, you just have to decide whether this is an important issue for your company and its operation in that particular state, and then proceed accordingly.
So remember, as we move through the coming political season listening to elected officials tell us how much they’re helping to create a world-class local business climate, don’t just take their word for it.
After all, numbers speak louder than words.
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