State Taxes Don't Matter Much to Entrepreneurship

The Small Business & Entrepreneurship Council made news this month by ranking South Dakota tops again on its Small Business Survival Index. As I have noted previously, the SBEC's index is more of an ideological wishlist than an analysis of actual small business performance.

The SBEC report also faces disagreement from one of the very experts it cites. To support his index's assumption that small businesses will thrive in states with low taxes, SBEC chief economist Raymond J. Keating (not a Ph.D.) cited work co-authored by Donald Bruce (a Ph.D.) that found decreases in marginal tax rates "might lead to increases in entrepreneurial entry and better chances of survival" (Bruce and Gurley, 2005, p. 24). Ignored by Mr. Keating is Dr. Bruce's finding in the same paper that "higher average tax rates on entrepreneurship income might actually increase the probability of entry" (p. 24).

Keating also ignores a November 2006 paper co-authored by Dr. Bruce with John Deskins for the Small Business Administration Office of Advocacy ("State Tax Policy and Entrepreneurial Activity"). To the good for Keating and the SBEC, Bruce and Deskins conclude that "Higher top tax rates on individual income, higher sales tax rates, and the existence of state-level inheritance or gift taxes all tend to slightly reduce a state’s share of the national entrepreneurial stock" (p. 2). They also find an apparent negative correlation between larger state and local governments and entrepreneurial activity (p. 22).

But Bruce and Deskins also knock at least a couple legs out from under the assumptions of Keating's index:

• "...top marginal state tax rates on corporate and individual income do not have statistically significant effects on state entrepreneurship rates..." (p. 2).
  
• "...states with higher sales tax rates tend to have higher entrepreneurship rates" (p. 2).
  
• "The composition of state tax portfolios is generally not a significant determinant of state
  entrepreneurship rates" (p. 2).
• "States with more progressive personal income taxes have slightly higher entrepreneurship rates" (p. 4).
• "...taxes have statistically significant but very small and scattered effects on entrepreneurship rates. Consequently, they are likely to be ineffective in generating desired changes in entrepreneurial activity" (pp. 5–6).

Interestingly, over the period of the Bruce and Deskins study, 1989 to 2001, South Dakota was one of only five states that saw the self-employed percentage of its workforce decrease (Bruce and Deskins, 2006, Table 1, p. 34). Even with our low-tax-no-tax policies and the 1990s boom, South Dakota saw the percentage of workers doing their own thing go down.

Bruce and Deskins's work shows the fatal flaw in Keating's report. The "Small Business Survival Index" does not measure the actual survival of small businesses; it advocates a specific anti-tax agenda which research shows does not have a big impact on small business activity.

In other words, Keating and the SBEC are more concerned with ideology than with what really works.

Minnesota 9th, South Dakota 39th in Small Business Performance

Small businesses do best in D.C.; Minnesota ranks 9th

South Dakota lags behind much of the nation in small business performance. According to the Lake Herman Institute's Small Business Success Index, South Dakota ranks 39th on concrete measures of small business success.

While the Small Business & Entrepreneurship Council's Small Business Survival Index ranks states by an ideological wish list, LHI's Small Business Success Index ranks states by the actual economic performance of their small businesses.

The U.S. Census Survey of Business Owners released this year finds that in 2002, there were 5.5 million small firms (i.e., employing fewer than 500 people). Table 1 compares the receipts and payrolls of those firms in South Dakota and surrounding states with the national figures:

Area	Number of employer firms	Rcpts for employers ($1,000)	Number of employees	Annual payroll ($1,000)
United States	5,508,048	8,311,958,607	54,236,327	1,686,205,038
Minnesota	111,378	178,789,074	1,150,026	35,689,776
Iowa	60,748	85,982,227	606,033	15,532,711
Nebraska	38,942	51,164,695	362,170	9,386,137
North Dakota	16,060	21,127,904	152,112	3,502,804
South Dakota	19,506	24,941,973	177,223	4,086,122
Wyoming	15,591	14,908,651	117,122	2,844,255
Montana	27,623	25,278,791	203,212	4,503,774

Table 1: Small Employer Firms, Rececipts, Employees, and Payrolls
Source: U.S. Census, 2002 Survey of Small Business Owners

To rank the states, the Small Business Success Index asks the following questions:

1. How much in receipts does each firm generate? More receipts mean more economic activity, a main goal of each state in fostering entrepreneurship.
   
2. How many jobs does each firm create? More jobs is an obvious measure of economic development success.
   
3. How much in receipts does each employee generate? The more economic activity produced per employee, the more successful the firm.
   
4. How much is each firm's payroll? More payroll means more money to support consumer spending in the local/state economy, another key goal of state economic development policy.
   
5. How much does each employee make? Higher wages increase the ability of the firm to attract and retain top workers who will sustain the success of the firm and contribute to community growth overall.
6. What is the ratio of receipts to payroll? The Lake Herman Institute takes the ideological position that a low receipts-to-payroll ratio represents a wider distribution of wealth among the employees. Sharing more of the firm's wealth with the workers who produce that wealth improves firm and community morale and empowers more citizens economically and politically.
   

By these metrics, South Dakota ranks well below national averages in small business performance. South Dakota's receipts per small firm in 2002, $1.28 million, are 85% of the national average of $1.51 million, but annual payroll per employee, $23,100, was 74% of the national average of $31,100.

Regionally, Minnesota offers the strongest small business performance, ranking 9th. Iowa barely makes the top half at 25th. Nebraska and North Dakota rank 31st and 36th, respectively. Wyoming (50th) and Montana (51st) are at the bottom of the Small Business Success Index.

	Rcpts/Firm	Emp/Firm	Rcpts/Emp
United States	$1,509,057	9.847	$153,254
Minnesota	$1,605,246	10.33	$155,465
Iowa	$1,415,392	9.976	$141,877
Nebraska	$1,313,869	9.3	$141,273
North Dakota	$1,315,561	9.471	$138,897
South Dakota	$1,278,682	9.086	$140,738
Wyoming	$956,234	7.512	$127,292
Montana	$915,136	7.357	$124,396

	Annual Payroll per Firm	Annual Payroll per employee	Rcpts/Payroll	SBSI rank
United States	$306,135	$31,090	4.93
Minnesota	$320,438	$31,034	5.01	9
Iowa	$255,691	$25,630	5.54	25
Nebraska	$241,029	$25,916	5.45	31
North Dakota	$218,107	$23,028	6.03	36
South Dakota	$209,480	$23,056	6.10	39
Wyoming	$182,429	$24,285	5.24	50
Montana	$163,044	$22,163	5.61	51

Table 2: Small Business Success Index Metrics and Rankings
South Dakota and Surrounding States

By these metrics, the place where entrepreneurs produce the best economic results is Washington, DC, with small firms producing the highest receipts per firm, the highest employment per firm, the highest pay per firm, and the highest pay per employee in the nation. Following the District of Columbia on the Small Business Success Index are Connecticut, Massachusetts, New Jersey, California, Illinois, New York, Texas, Minnesota, and Michigan.

Download the complete spreadsheet and check the numbers yourself!

SD Best for Small Business? No: Media Trumpets Right-Wing Propaganda

South Dakota's paid media are happily touting the 2009 Small Business Survival Index, which ranks South Dakota as the best state for entrepreneurship, as actual news. In reality, the report from the DC-based Small Business & Entrepreneurship Council is right-wing propaganda. Report author and SBEC chief economist Raymond J. Keating performs no analysis of small business survival rates or or economic output. Instead, writes Keating,

...The Index ranks the states according to their public policy climates for entrepreneurship.

This fourteenth annual “Small Business Survival Index” ties together 36 major government-imposed or government-related costs impacting small businesses and entrepreneurs across a broad spectrum of industries and types of businesses..." [Raymond J. Keating, "Small Business Survival Index 2009: Ranking the Policy Environment for Entrepreneurship Across the Nation," Small Business & Entrepreneurship Council, December 2009].

In other words, Keating starts with a Grover Norquist wishlist of anti-government positions and doles out top rankings to states that most resemble 1990s-style Russian anarcho-capitalism.

In Keating's scoring scheme, taxes are, of course, an unalloyed evil. The ideal score would go to a state with no taxes and thus no method of funding roads, police, schools, or parks (would such a utopia really be the best place to start a business?). Even taxing Internet sales, an idea Governor Rounds has floated for years, lowers your state's standing the SBEC's eyes. States also lose points for imposing any mandates on health insurers, including requiring them to cover the self-employed. Keating further brands pro-family states bad for business when they mandate paid family leave.

Evidently when Keating says a state is good for "entrepreneurs," he means for Henry F. Potter, not George Bailey.

Not one of Keating's 36 metrics measures actual economic performance. Not one gauges whether you'll find a welcoming business environment or whether small-town politics will block you at every turn from competing with the existing business powers of the community.

And not one of the local news stories trumpeting the SBEC report tells you that the Small Business & Entrepreneurship Council, neé the Small Business Survival Committee, is an industry-funded lobbying group associated with Grover Norquist's drown-government-in-the-bathtub Americans for Tax Reform. The local news ignores that SBEC chief economist Raymond J. Keating (MA, not Ph.D) attacks open-source software (a critical component in making the Internet work) and likens it to the Borg (subtext: open source is bad because it cuts into his corporate backers' profit margins). Our paid journalists ignore that SBEC president and CEO Karen Kerrigan is "a seasoned player in the conservative movement."

The SBEC's propaganda (and the paid press's parroting thereof) reminds me of the reporting on the "freedom index" last March. Some political advocates cook some formulas to suit their agenda, and local reporters chirp, "Oh, look! Pretty numbers!"

I'll have some real numbers coming up to show the flimsy case Keating and the SBEC make. But for now, remember to always look for the people and the agenda behind the conservative curtain.