Quick Hit Ellyn Fortino Thursday May 2nd, 2013, 1:36pm

New Study Challenges Prominent Business Climate Rankings (UPDATED)

Prominent studies that rank states’ business climates often contradict each other and should not be used to inform public policies, according to a new “Grading Places” report published by the Washington, D.C.-based Good Jobs First.

“There’s no such thing as a state business climate,” said Greg LeRoy, executive director of Good Jobs First, on a conference call with reporters. “One size can’t fit all. Things vary much too much among different kinds of business facilities and among metro areas. There are no silver bullets. There [are] no magic variables.” <--break->

Popular rankings, such as the Beacon Hill Institute’s "State Competitiveness Report" and the Tax Foundation’s "State Business Tax Climate Index," fail to predict which state economies will thrive, said economist Peter Fisher with the University of Iowa, who authored the report.

This second edition of the Grading Places study, which examined four different index ratings and two representative firm models attempting to rank state business climates, is the third time in 27 years that such an analysis has been published, LeRoy pointed out.

“We think it’s vital today given the number of the debates going on in states right now around tax breaks and other things being enacted in the name of so-called better business climates,” he said.

The study called out the Beacon Hill Institute’s model, citing various problems. One issue in particular is “fatal,” Fisher noted.

“They have missing data for a lot of the measures that they want to include in their index,” Fisher said. “How did they solve that problem? They make up numbers, and I am not kidding.”

Twenty-one percent of the data in the Beacon Hill Institute's rankings is made up, according to Fisher.

“I see no reason at all [to] pay any attention to what they have come up with,” he said.

The study also looked at the Small Business and Entrepreneurship Council’s "U.S. Business Policy Index" and the American Legislative Exchange Council’s "Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index."

Each of the four aforementoned indexes take a large number of measures that the particular organization claims are a part of a state's business climate, and adds them together to create a single number, which is supposed to represent the actual climate, said Fisher.

But the organizations that put out these rankings often have a clear agenda, Fisher explained.

“They’re all basically tax-cutting, government-shrinking organizations. That’s their goal,” he said. “Their goal is to change state policy, so they have to invent a state business climate in order to do that.”

There are different ways the various indexes are used.

States may seek out an index where they are highly ranked in order to promote themselves as a good place to do business. Also, if a state legislature or business lobby, for example, is pushing for lower taxes, it might look through the rankings to find one that rates the state poorly and “use that as ammunition in their campaign to cut business taxes,” Fisher said.

The most cited measure is the Tax Foundation’s "State Business Tax Climate Index," and it has three major problems, according to the study.

There are 118 individual tax features that are combined in the measure. And the way they are weighted, such as the number of brackets or the top income tax rate, is “completely arbitrary,” Fisher said.

“When we re-weighted them using sensible weights, we found most states changed rankings, not surprisingly,” he explained.

Also, the index ignores significant features of the tax code, including single sales factor apportionment formula, the study noted. Under the formula, a corporation's overall profits taxed by a state are based only on the portion of sales made to customers within the particular state.

“It’s not even part of their index,” Fisher stressed.

And finally, the index is not a measure of what businesses actually pay.

“They even claim it’s not trying to be, and yet, at the same time, they argue that’s what matters,” Fisher said.

The Small Business and Entrepreneurship Council’s "U.S. Business Policy Index" is as a measure of state tax policies that encourage innovation and growth.

But Fisher explained that the index has 46 variables, but only 12 of them regarding tax progressivity mattered in creating their overall index. The others were “random noise,” he said.

Finally, the American Legislative Exchange Council’s "Rich States, Poor States: the ALEC-Laffer Economic Competitiveness Index" is supposed to indicate what state policies produce growth and prosperity, Fisher said.

But according to the study, the index appears to have no discernible effect on growth. States that follow the policies outlined in ALEC's index actually tend to have lower levels of growth when it comes to incomes and wages, according to Fisher.

The "Grading Places" report also examined representative firm models, including the Council on State Taxation’s Competitiveness of State and Local Business Taxes on New Investment, which is prepared by the accounting firm Ernst & Young. The report also looked at the Tax Foundation’s Location Matters model, which is done in tandem with the KPMG accounting firm.

These models create national characteristics of hypothetical firms based on real world businesses. The models run those firms through the tax code in every state to see what they would actually pay, meaning the method doesn’t use an arbitrary weighting system like the aforementioned indexes do, Fisher said.

Even still, the study noted problems with the representative firm models.

“The results vary dramatically depending on what kind of business you’re modeling,” Fisher said.

An individual manufacturing firm’s results, for example, may have some credibility, he said. But the results often varied among different manufacturing sectors within the same state.

“The concept of the state business climate probably is not a valid one,” Fisher concluded. “There is a tax climate for a particular kind of business, in a particular metropolitan area, but to try and come up with an overall business climate, or just a tax climate, for all kinds of businesses everywhere in a state is not a helpful exercise. It conceals far more than it reveals.”

UPDATE 1 (5/3/13, 12:07 p.m.): Good Jobs First removed the "Grading Places" study temporarily from its website Thursday pending a review based on concerns from the Beacon Hill Institute. A spokesman for Beacon Hill said in an email to Progress Illinois that the "Grading Places" study relied on a misleading analysis of it's index data sheets. The spokesman said Good Jobs First and the study's author did not ask for Beacon Hill's data for the study. In an email to Good Jobs First, Beacon Hill's index author Jonathan Haughton expressed a willingness to provide the data, according to the spokesman.

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