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Friending Business

Wednesday, May 30, 2012

How would you rate your state’s support of small business owners?

Rankings are hot. It seems like every month a think tank or magazine produces yet another best/worst ranking of states and cities along a variety of dimensions. These range from the serious and semi-scholarly (taxes, governance) to the whimsical (places to find dates). Sometimes, the effort appears counterintuitive: If a city or state is said to have the best job market, will it be arbitraged away?

The most popular rankings—in terms of the weight they carry and their usefulness—are those that look at state economies. Each year, several studies are published that rank the 50 states by taxes, business climates, competitiveness, innovation, and other related topics. As the rankings industry has grown, however, so too has criticism of their methodology and, importantly, their findings. For example, Jed Kolko and his colleagues discovered that, amusingly, 34 out of the 50 states could stake a claim to a top 10 business climate ranking across various studies. Another study, looking at nine reports, found seven different number one states, and that four of those “number one” states ranked near the bottom in other reports!

In our own reading of various rankings, we noticed that Kansas, for example, ranks tenth in a doing business report and 13th in a competitiveness report, but 35th in a separate ranking on its business tax climate. Massachusetts experiences even greater volatility among the rankings: Number one for quality of life, 50th in business costs, 36th in corporate taxes, 43rd in property taxes, third in overall competitiveness, and second on human development. If it is difficult to square some of these rankings with each other, it is even harder to find correspondence with economic reality—studies have shown that such rankings have little bearing on the actual business climate faced by entrepreneurs and companies.

34 out of the 50 states could stake a claim to a top 10 business climate ranking across various studies.

One reason for this is that, by necessity, rankings tend to gravitate toward those levers that policymakers can pull: Taxes, regulations, incentives, and so on. This naturally appeals to policymakers but it overstates the impact of policy on the overall business climate. Three years ago, a study of MIT alumni entrepreneurs found that taxes and regulations were less important factors affecting the location of their businesses than access to talent, quality of life, networks, and where the founders already lived. The rankings also blanket over variation: On the ground, the “business climate” can vary by sector and even within sector in terms of firm-level impact.

The second reason that business climate rankings turn out to be so imprecise and volatile is that they attempt to measure the business climate through the theoretical impact of a list of generic factors. Only rarely do studies view a state’s business climate from the perspective of individual firms and business owners. The best recent example of this approach is a research project by Thumbtack.com, an online marketplace for over 200,000 businesses of all kinds. Importantly, Thumbtack has been growing rapidly since its founding in 2009, adding over 5,000 new businesses to its listings every week.

Working with the Kauffman Foundation, Thumbtack conducted a large-scale survey of listed businesses on “Small Business Friendliness” by state. Instead of measuring states by the ideology-driven criteria of a ranking report, the Thumbtack survey simply asked, “How would you rate your state’s support of small business owners?” The findings are highly intriguing.

For overall small business friendliness, the top states are Idaho, Texas, Oklahoma, and Utah, which accords generally with other state rankings. The top cities followed this pattern, with Oklahoma City, Dallas-Fort Worth, San Antonio, and Austin topping the list.

Occupational licensing restrictions are an important but often overlooked barrier to entrepreneurship.

Interestingly, according to the report, “licensing requirements were nearly twice as important as tax-related regulations” in assessing a state’s small business friendliness. This echoes the findings of other recent research, which found that occupational licensing restrictions are an important but often overlooked barrier to entrepreneurship.

What is most important about the Thumbtack survey is that it does not restrict itself to general findings by state or city. Instead, for each state it offers an entire menu of grades: Ease of starting a business; cost of hiring; friendliness of zoning regulations; publicity of networking programs; and several more. Virginia, for example, receives an A grade for overall friendliness, but a B on zoning regulations. Rhode Island, which ranks at the bottom on the overall grade, scores well on hiring costs, training programs, and networking programs (each with an A+). This range of grades highlights the multitude of factors that go into determining a state’s headline ranking. Further, Thumbtack offers a regional breakdown by grade and business location within each state. Interested in how the Portland, Oregon, metropolitan area differs from its surrounding region, or how southeastern Florida differs from northwestern Florida? These are the types of differences that matter to entrepreneurs.

Most interestingly, for each state and regional location within the state, Thumbtack provides selected comments by business owners. This qualitative feedback underscores both the specific challenges facing entrepreneurs (paperwork, finance) and the business-to-business variation within states. California receives an overall grade of F, but there is wide variation between the San Francisco Bay Area and the Central Valley. An auto mechanic in Stanislaus reports that licensing takes months, while a marketing consultant in San Francisco says the entire state appears to be “anti-business.” Yet an event videographer in Ventura praises an “amazing and supportive” environment.

In the end, certain states and regions offer a better business climate—or at least the perception of it—than others. The Kauffman Foundation’s further in-depth analysis shows that this holds true even when controlling for economic growth rates across states. What exactly is meant by “better,” of course, remains murky. It will vary by type of business and geographic region. We hope that state and local governments will closely study the Thumbtack findings, rather than stopping at the headline findings.

Dane Stangler is research director and Yasuyuki Motoyama is senior scholar at the Ewing Marion Kauffman Foundation.

FURTHER READING: Scott Shane writes “Understanding Just How Harmful Obama’s Tax Hikes Would Be,” “When Reducing Barriers Leads to More Failed Businesses,” and “Why Aren’t Banks Lending to Small Business? Ask Bernanke.” Alan D. Viard discusses “The Misdirected Tax Debate and the Small Business Stock Exclusion.” Chad H. Hill contributes “Corporate Income Tax Reform: The View from the States.” Douglas Smith authors “States Rise up Against Federal Overreach.”

Image by Rob Green / Bergman Group

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