Texas public policy foundation
What makes Texas the most small business-friendly state, and Rhode Island the least
 
COMMENTARY
 

This commentary originally appeared in Forbes on August 18, 2015.

For the fourth year running, California and Rhode Island earned an “F” in a massive survey of small business owners rating state and local governments’ friendliness to small business. At the other end of the spectrum, also for the fourth year in a row, Texas and Utah earned an “A+” from entrepreneurs.

What matters to small business owners? Nearly 18,000 entrepreneurs surveyed by Thumbtack.com said: Chamber of Commerce-style training and networking; regulatory and licensing simplicity, helpful government websites to cut red tape, and taxes.

In addition to Texas and Utah, small business owners rated New Hampshire, Louisiana, and Colorado as the best places for business. Aside from California and Rhode Island, Connecticut, and Illinois received “F” grades, closely followed by Massachusetts, Maryland, and New York with “D” grades.

Thumbtack.com, a service firm that links consumers to businesses, has a vast network of business owners across the nation and surveys them regularly. They are rightly concerned with a decline in American entrepreneurship, citing a multiyear drop in business starts as part of a “…broad collapse of self-employment across industries and states…” according to Thumbtack.com’s chief economist, Jon Lieber. Lieber’s survey data pegs some of this collapse on red tape with “Small business owners… frequently frustrated by unnecessary bureaucratic obstacles.”

Regulatory compliance can be costly. A state-funded study out of California looked at the costs in time and fees for business owners to fill out paperwork to avoid fines and stay out of prison (as a California Assemblyman, I voted for the bill in 2006 that created the study). Heavily opposed by government employee unions such as the American Federation of State, County and Municipal Employees (AFSCME), the AFL-CIO and the Teamsters, the study found that regulatory compliance costs were almost five times the state’s general fund budget, about $493 billion, resulting in a loss of one job per small business or about $134,000 per small business in 2007.

Being unfriendly to business isn’t good for the economy. Thumbtack.com’s Lieber found a strong correlation between higher rates of state economic growth and states with small business-friendly policies.

When seeking correlations between Thumbtack.com’s small business friendliness survey results and 64 measurable factors such as poverty rates, the economy and demographics, three measures stand out: regulations, taxes, and the extent of government worker unionization (the latter explaining why California’s small business regulatory cost bill was opposed by government unions in 2006).

On the regulatory front, the Fraser Institute in Canada publishes an annual study of economic freedom in North America. Among several sub-factors, Fraser rates business regulations at the state and provincial level. The figure below shows a high degree of correlation between the regulatory burden and small business satisfaction, verifying a key finding of the Thumbtack.com report.

Small business owners view states with less burdensome regulations as more friendly to small business

Small business owners view states with less burdensome regulations as more friendly to small business

Of course, you can’t pay for regulations without taxes and, while Thumbtack.com’s work showed that tax code complexity was more important than tax rates in entrepreneurial satisfaction; our own analysis appears to show a strong linkage to the level of state and local taxation, as per the Tax Foundation, and small business views of state friendliness to their operations.

States with lower taxes as a share of income score higher on small business friendliness

States with lower taxes as a share of income score higher on small business friendliness

Lastly, you can’t regulate and collect taxes without government workers and, in many states, a large portion of those workers are represented by unions. Interestingly enough, the correlation between small business satisfaction and the percentage of unionized government workers is the highest among the 64 items tested—the R-squared is 0.5331—with higher levels of unionization linked to low levels of small business friendliness.

States with lower taxes as a share of income score higher on small business friendliness

States with lower taxes as a share of income score higher on small business friendliness

Among the states surveyed, the five with highest level of state and local government worker unionization were New York (73% unionized, grade D), Rhode Island (71% unionized, grade F), New Jersey (66% unionized, grade C-), Connecticut (64% unionized, grade F), and Massachusetts (61% unionized, grade D+). The linkage between a unionized workforce and hostility to small business deserves additional scrutiny. It doesn’t take much to imagine that a nearly-impossible-to-fire unionized government bureaucrat might behave boorishly to some poor schmo tying to complete his licensing forms in quintuplicate.

The tyranny of regulatory compliance that Thumbtack.com identifies was foretold in 1835 by Alexis de Tocqueville when he warned of a “soft despotism” formed from “a network of small complicated rules” enforced by a bureaucracy run amok.

Fortunately, Texas and Utah show a different path—one that encourages business ownership through lower taxes and less burdensome regulations. And, with the growing prevalence of automation, combined with international competition, Americans need greater opportunity for small business ownership, not less.

Chuck DeVore is Vice President of National Initiatives at theTexas Public Policy Foundation. He was a California Assemblyman and is a Lt. Colonel in the U.S. Army Retired Reserve.