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New firms drive state’s economic growth

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John Hood
Syndicated

Monday, February 12, 2018

Politicians in North Carolina and just about everywhere else in the United States seem fixated on attracting large companies to their states, often by any means necessary.

This fixation is mistaken but understandable. We all want North Carolina to be so congenial that big-name companies will want to do business and employ people in our state. Plus, politicians are human beings, too (insert joke here). We all tend to focus on the familiar. We have what psychologists call “hindsight bias” and “status quo bias.”

There is also a basic rhetorical problem. I strongly believe policymakers should focus more on entrepreneurs, on new businesses and the disproportionate number of net new jobs and income gains they produce for a state’s economy. But by definition, I can’t point you to specific individuals or firms deserving of politicians’ attentions — because no one can know their names yet!

That’s a key feature of entrepreneurship. It’s about discovery. Many startup businesses fail quickly. Most never become large enterprises that employ lots of people or become household names. The ones that do — the Apples, Amazons, and Facebooks — are easy to spot in hindsight, sure, but rarely with foresight. And by the time politicians take notice of them and start chucking incentive grants at them, some have already completed their highest-growth phase or are about to experience a reversal of fortunes, as North Carolina experienced some years ago when it heavily subsidized a Dell plant that didn’t operate for very long.

Rather than try to guess which economic trees will grow the tallest, politicians should focus on the economic forest — or more the point, on the economic climate, soils, and other conditions that may help widely dispersed entrepreneurial seeds sprout and grow into forests.

Both in Washington and in Raleigh, lawmakers have correctly discerned that the corporate tax rate is one such condition. While changes to the personal income tax got the lion’s share of attention during the December debate about federal tax reform, the most important changes in economic terms involved business taxes.

Thanks to Congress, America now has a far more rational system for corporate taxation. It imposes a lower marginal tax on a broader tax base, and no longer encourages companies to park their international earnings overseas to avoid double-taxation. More capital is likely to flow into our country in the coming months and years — and because of other tax changes, that money is more likely to flow into new plants, equipment, and other investment.

A lower corporate tax doesn’t just boost investment and employment by existing firms, however. There is compelling evidence to suggest it also boosts the rate at which people create new businesses, by raising the after-tax rate of return on what is almost always a risky investment.

The latest paper I’ve seen on the subject, a Federal Reserve Board study by Wake Forest University economist Mark Curtis and Fed economist Ryan Decker, found not only that states with higher corporate taxes tended to have weaker business activity but that “startups are seen to be more sensitive to these tax changes than incumbent firms.”

Conservative leaders in North Carolina understand the importance of using tax policy to reduce the risk of starting new businesses. Under their leadership, the state’s corporate tax rate will soon be just 2.5 percent, the lowest rate of any state that taxes corporate income.

This will likely accentuate what is already a positive trend in entrepreneurship. According to a 2016 Kauffman Foundation report, our state ranked 8th in “business startup activity” among large states. So far in 2017, North Carolina’s rate of new-business formation has exceeded the national average.

For every high-touted industrial prospect that goes to some other state, just keep in mind that many more young, less-famous companies are looking for the right place to launch and begin their growth cycles. In the long run, they will form a more secure footing for sustained economic growth. Tax policy isn’t the only technique for cultivating them. But it matters.

John Hood (@JohnHoodNC) is chairman of the John Locke Foundation and appears on “NC SPIN,” broadcast statewide Fridays at 7:30 p.m. and Sundays at 12:30 p.m. on UNC-TV.

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