Fate of the States: The New Geography of American Prosperity (16 page)

State Arbitrage

In the business world, any smart up-and-comer will be quick to exploit a competitor’s weakness. Under Armour, for example, did not rest on its laurels after it cut in half Nike’s lead in sports-apparel market share; no, Under Armour went for the jugular, launching a footwear line that now accounts for 12 percent of the brand’s total sales.
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What do sneakers and gym shorts have to do with jobs and state finances? Well, imagine for a moment that California is Nike and that Texas and North Dakota are Under Armour, and suddenly you get a clear picture of what’s at stake. Texas and North Dakota are not resting on their laurels. They want California’s jobs. And the reality is that California is far, far more vulnerable than its sneaker-company doppelganger.

By mid-2006 the real cost of homeownership in California was more than twice the national average. The ratio of average home price to per-capita income was 9.7 in California versus 4.2 for the United States nationally. The price-to-income ratio in Texas was a mere 2.6. Was it really worth over three and a half times more to live in California than in Texas? Perhaps the public schools in California were superior. Maybe proximity to the California coastline or the Sierra Nevada ski slopes was worth some sort of a real-estate premium. But just how much? It’s not as if the California job market was much of a lure: In the early 2000s California’s unemployment rate was 20 percent higher than the national average, and by 2010 it was 33 percent higher. By late 2012 California’s home price–to–income ratio—while still above the national average—had narrowed to 6.6.
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What happened is that people were beginning to vote with their feet. Not only was the cost of living in certain parts of the country no longer justifiable, but also differences between state and local taxes were eroding the desirability of certain locales. At a time when the country has a true structural unemployment epidemic, when recovery from the Great Recession seems painfully slow, and when almost 25 percent of U.S. mortgages are larger than the value of the underlying properties, the fiscal condition of individual states has never been more important. These differences are driving a bigger and bigger wedge between Americans at the most basic levels. Businesses are fleeing housing-bust states for those with relatively low tax rates and more business-friendly policies. Rich people are aggressively choosing their state of residence based on tax rates, the quality and safety of services provided, and the overall fiscal health of a state.

Take New Jersey. The ratio of average home price to per-capita income there was 5.2 in late 2012, 36 percent higher than the national average. But New Jersey residents weren’t just paying more for their homes relative to their incomes. They were also paying a lot more in taxes for the privilege of living in the Garden State. In 2009, according to the U.S. Census Bureau, New Jersey had the highest state and local tax burden as a percentage of personal income in the United States at 12.2 percent. To put that into context, the national average was 9.8 percent and New Hampshire, Texas, and Wyoming had burdens of 8.0 percent, 7.9 percent, and 7.8 percent respectively.
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I was born in New Jersey, and some of the best memories of my childhood are from summers spent at Beaver Lake in Sussex County. Some of my best memories of my midtwenties are summers spent in Bay Head, a small beach town. But is living in New Jersey today, with significantly worse infrastructure and public services, worth five times the national average cost of living? Certainly not for me—I don’t live in New Jersey.

Fiscally speaking, states have never been more unequal than they are today. They are unequal in the amount of debt per capita they carry. They are unequal in the tax rates they levy on individuals, corporations, and sales. They are increasingly unequal in terms of public safety and overall quality of life. Government policy has done a lot to contribute to this inequality. Did a state rein in spending and control debt levels, or did a state push tough decisions off until later, piling on more debt and underfunding pension obligations so it could continue to spend beyond its means?

Whatever the federal tax policy, Americans pay the same federal income-tax rates regardless of where they live. However, local and state income taxes vary widely. The most obvious example is that Texas, Nevada, Florida, Wyoming, South Dakota, Washington, and Alaska do not tax individual income, whereas California recently voted to raise income-tax rates on any resident earning over $1,000,000 by nearly a third, to 13.3 percent
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—the highest state income-tax rate in the country. If you make over $250,000 a year, you will now pay 10.3 percent. Compare that with Texas or Florida, where there is no zero income tax for anyone. That’s nearly $26,000 less in after-tax income for a Californian earning $250,000 year.

Companies are paying attention to more than just taxes when deciding on investing in states. Twenty-three states in the United States are “right to work” states, which means workers in those states cannot be required, as a condition of employment, to join a union or pay union dues. Companies argue that this gives them more flexibility to manage their head count and stay competitive. Just last year, Indiana became the latest state to pass a right-to-work law in order to attract more business investment.
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This isn’t about being prounion or antiunion. It’s about being proreality.

Like it or not, companies like Boeing want maximum flexibility in their labor forces, and they’re choosing to expand in or relocate to states that give them what they want. According to a study by Ohio University economist Richard Vedder, job growth in right-to-work states was almost double that in non-right-to-work states from 1977 to 2008. From 2000 to 2009 domestic migration from non-right-to-work to right-to-work states accounted for a 5 percent population swing.
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What’s more, since 2008 right-to-work states have grown their economies over three times as fast as non-right-to-work states. Specifically, right-to-work states grew their economies by 55 percent from 2001 to 2011, faster than the average for the United States (47 percent) or for non-right-to-work states (41 percent). Average unemployment in July 2012 in right-to-work states was 7.2 percent, versus 8.3 percent in the United States overall. Personal income in right-to-work states grew by 54 percent from 2001 to 2011, 17 percent faster than the U.S. average and 30 percent faster than forced-union states. Average bonded debt in right-to-work states is 3.8 percent of their GDPs, versus 5.8 percent in forced-union states, a difference of over 50 percent. But when you add together bonded debt and unfunded pension and health-care liabilities, the difference is an astonishing 81 percent higher burden in forced-union states. And once again the burden of those obligations goes directly to state residents.
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There is an expression on Wall Street, “smart money,” that is used to describe fancy hedge-fund and mutual-fund managers who ferret out little-known information about companies, products, or markets. They figure out how to profit from that information via stocks, bonds, or commodities, make their moves early, and, by doing so, make the big bucks. “Dumb money” describes the masses that find out information only after it is too late and act well after the smart money. In some cases the “dumb money” people find out information so late they lose their shirts. They wind up making the absolute wrong investment decision at the wrong time—when the “smart money” is already out the door. Smart-money thinking applies to states too. The smart money (in this case, large corporations and wealthy people) is exiting high-tax, troubled states to low-tax, higher-service states. Companies like Boeing, Google, Intel, Amazon, Toyota, and Facebook are deciding to build their expanded business operations outside their home states in places like Texas, Indiana, Oklahoma, and South Carolina. In Connecticut and Massachusetts, a recent survey conducted by the Connecticut Business & Industry Association found that half of businesses with fifty or more employees in the Hartford-Springfield Knowledge Corridor had considered moving and a quarter had already been approached by other states.
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The smart money isn’t just escaping taxes that are high today but future tax hikes as well. The smart money understands that taxes can only go up given the massive sums of bonded debt and unfunded pension and health-care liabilities coming due in future years. Thanks to reckless fiscal mismanagement by cities and states, individuals and corporations still residing in those states will all be on the hook. The smart money also understands that with those higher taxes will come a lower level of public services—that the states in the deepest fiscal trouble have far fewer resources to invest in roads, bridges, airports, education, public safety, and all the other things relocating businesses look for in a new home.

No wonder smart money is flocking to states with lower tax burdens and less strained budgets. The dumb money is those left behind to pay higher taxes for lesser services. From 2009 to 2010, 12 percent of people moving out of California moved to Texas, almost halfway across the country.
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The fact is that California’s total obligations—obligations that can be escaped by the simple act of moving—increased almost 50 percent in one year alone. During the same time period, 15 percent of the people leaving New York moved to Florida. Some folks don’t even have to move that far to get relief. Property taxes in Pennsylvania are almost 50 percent below those of neighboring New Jersey (which has the highest property taxes in the nation), and Pennsylvania’s income-tax rate of 3.07 percent is nearly a third lower than New Jersey’s 8.97 percent top rate.
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To be sure, there’s nothing new about people moving to take advantage of lower taxes or better schools. But today these relocations are increasingly cross country. The states with the best employment growth since 2007 are all non-housing-boom states: North Dakota, Texas, Alaska, Oklahoma, and Louisiana. The worst: Nevada, Arizona, Florida, Alabama, and Rhode Island.
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In its annual Investment Monitor report, accounting firm Ernst & Young tracks what it calls “mobile capital investments”—essentially business investments that could be made anywhere and are not tied to a specific geographic region (like a copper mine, for instance). According to E&Y, the states landing the most jobs from these investments were Texas (30,100), Pennsylvania (27,100), Ohio (26,200), Virginia (23,100), and North Carolina (20,300). As a side note, little Indiana picked up more jobs from “mobile” business investment (14,500) than did New York (12,300).
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State and local governments owe over $6 trillion that we know about. This works out to about $16,600 per capita, but a lot of that money—especially the $2 trillion in debt amassed over the last decade—is not distributed evenly. In New Jersey the total tax-supported debt per capita is a staggering $15,000. In nearby Pennsylvania that number is just $7,000. The contrast is even more dramatic when comparing Illinois and next-door neighbor Indiana. Illinois has a total tax-supported debt per capita of almost $16,000. Indiana: $2,500.
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The less an individual owes, the more that individual can spend, and the same truism holds for states. Raising taxes and cutting social services is a vicious cycle. The higher the tax rates, the more strained the revenues become as people and businesses flee to avoid higher taxes. The result: less money for social services. Property values continue to decline, wealth declines, and jobs leave. This is exactly what is happening to the most deeply indebted states in the United States.

In prior U.S. economic cycles, industrial revolution and evolution were the catalysts causing regional economies to rise and fall. Geography often played a key role. The lamp oil produced by New England’s whaling industry once illuminated the world—until the drilling of the first oil well in Pennsylvania in 1859 put the whale-boat captains out of business. (Yes, oil saved the whales.) Hollywood was created practically overnight in the early twentieth century when filmmakers abandoned New York and New Jersey for California’s superior sunlight—and also to escape the East Coast lawyers of Thomas Edison and his motion-picture patents.

This time around geography is almost irrelevant. In today’s mobile, digital, overnight-shipping economy, there’s no physical reason why Electronic Arts can’t design video games in Austin, Texas, instead of Redwood City, California, just as there’s no reason Boeing can’t build new airplanes in South Carolina instead of Washington State. Government inaction and ineptitude is causing once-vibrant communities to become decrepit and once-sleepy ones to emerge as the new job magnets. Voters and communities are starting to realize just how closely tied their personal economic well-being is to their communities’ fiscal well-being. Voters in the mismanaged states, the ones now flushing away jobs, are rising up and putting their feet down. Unemployed workers are packing up their families and relocating to low-tax, non-budget-crunched states like Texas and North Dakota in order to find work.

Moving has become an easier decision for businesses too. Consider, for instance, a corporation headquartered in Silicon Valley. The average corporate tax rate in California is over 8.8 percent and the average sales tax is 7.25 percent. Sure, property taxes are kept in check by Proposition 13, but the cost of living is higher than in most other states and social services are vanishing. Moving a business next door to Nevada, with zero corporate taxes and a lower cost of living, seems reasonable enough, and businesses and individuals have been making such moves. No longer is that competition solely between neighbors. Nowadays a state on one side of the country could be competing with a state thousands of miles away. Indiana, for instance, has actually been running print ads in California that show a coffee-shop napkin with the following handwritten message from Indiana: “Admit it, you find me fiscally attractive.”

Indiana governor Mitch Daniels is not the only central-corridor governor mounting a full-on assault on states like California, Illinois, New York, and New Jersey in a bid to lure individuals and businesses. Companies are relocating and channeling investment dollars from struggling states to strong ones like never before. Toyota announced in 2012 its factory-expansion plans in Indiana, investing $400 million to move the production of its Highlander to Indiana from Japan.
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Boeing plans to close a plant it had operated since 1929 to move all future operations to Oklahoma and Texas.
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Google spent $700 million to add a new data center in Texas. Amazon and eBay are also investing hundreds of millions to build out facilities in business-friendly Texas.
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