CEOs vs. Small Business Owners on Which Policies Make for a Business-Friendly Climate

Which public policies make an economy better for business? One way to answer this question is to ask businesspeople. Two recent surveys ask businesspeople to rank the American states on their friendliness toward business.

Now, libertarians often remind us that friendliness toward business is not the same as friendliness toward markets. Indeed, libertarians believe that many of their favored policies, such as abolishing trade protection, corporate welfare, and regulations that privilege big business, will redound to the benefit of workers and small business owners. What’s so interesting about these two surveys is that they are of different types of business owners: CEOs of large companies and small businesspeople. The first survey was conducted by Chief Executive magazine and the second by in partnership with the Kauffman Foundation. By relating respondents’ views about the friendliness of their states to those states’ actual policies, we can see where big and small businesses agree and disagree about which policies are most important for their success.

My first step was to draw out of these survey data those numbers that relate specifically to different states’ policy environments, as opposed to other aspects of the economic climate. From the CEO survey, therefore, I took the taxation/regulation score given for each state (higher is better). From the small business survey, I took the “Regulations” component grades. Unfortunately, the small business survey does not include raw scores for each state, so I simply quantified the grades as follows: A+ = 0, A = 1, A- = 2, and so on, up to F = 11. The small business survey only covers 45 states, but for these states, the correlation between CEO and small business scores was -0.76. Since higher is better in the CEO survey and lower is better in the small business survey, that high correlation indicates a surprising degree of agreement between large and small businesses about states’ friendliness toward their businesses.

Nevertheless, there may remain some important differences in which policies large and small businesses prioritize. To get a handle on this question, I conduct regression analysis on states’ survey scores, with state policy indicators as the independent variables. These regressions help us answer the question: Which policies matter more and less to businesspeople’s perceptions of their state’s overall climate?

What actually matters may differ from what survey respondents claim matter, if policies in one area – or even the general political climate – condition what people expect in other areas. To some degree, a progressive, say, might complain that these surveys are biased because businesspeople tend to be conservative or libertarian, and they will therefore rate down states with a left-of-center political climate, even if their policies are not in fact harmful to business. A response might be that perceptions nevertheless matter: if businesspeople hesitate to invest because they irrationally fear harmful policies, that irrational fear is causally efficacious nevertheless. But another response, I think, is that small businesspeople are usually not the wealthy fatcats of progressive loathing: they’re carpenters, physical therapists, realtors, interior designers, laundromat owners, and the like. I would hypothesize that small businesspeople are more ideologically diverse than CEOs of large businesses, but I know of no evidence on that question offhand.

Here are the independent variables I use the analysis:
1) State and local tax revenue as a percentage of personal income, excluding mineral severance and motor fuel taxes, fiscal year 2009 (a rough but pretty good measure of the tax burden);
2) State and local spending on “protective inspection and regulation” as a percentage of personal income, fiscal year 2009;
3) Effective state gas taxes per gallon, 2010 (not a big issue in itself I don’t think, but probably a good proxy for environmental regulation more broadly);
4) Residential land-use regulation index (I adjust the Wharton data slightly by excluding certain potentially market-friendly limits on development, such as impact fees, and double-weighting the economically irrational policy of building permit caps);
5) Several “regulatory freedom” categories from Ruger and Sorens (2011) (you need to download the spreadsheet to get the component scores):
a) freedom from occupational licensing;
b) freedom from eminent domain abuse;
c) freedom from tort/liability abuse;
d) health insurance freedom;
e) labor market freedom;
f) educational freedom (this is actually part of the Ruger-Sorens “personal freedom” index, but I included it anyway).

Here are the results for the CEO survey regression (to make the results comparable with the small business survey, I run it on only the 45 common states, but the results are similar for all 50):

Estimate Std. Error t value Pr(>|t|)
(Intercept) 10.981 1.452 7.560 8.84e-09
Taxes -0.601 0.158 -3.797 0.000577
Inspection & regulation spending 8.876 3.322 2.672 0.011490
Gas taxes -1.450 2.137 -0.679 0.501872
Land-use regs -0.014 0.059 -0.232 0.818162
Tort freedom 0.385 0.164 2.347 0.024880
Occupational freedom -0.081 0.160 -0.507 0.615238
Eminent domain freedom 0.073 0.167 0.434 0.666679
Health insurance freedom 8.325 4.397 1.893 0.066832
Labor market freedom 26.739 4.789 5.583 3.00e-06
Education freedom -0.155 4.292 -0.036 0.971456

Residual standard error: 0.8907 on 34 degrees of freedom
Multiple R-squared: 0.8431, Adjusted R-squared: 0.797
F-statistic: 18.27 on 10 and 34 DF, p-value: 6.659e-11

So we can be highly confident that high taxes, labor market and health insurance regulations, and a business-unfriendly court system are associated with lower CEO evaluations of a state’s business climate. The other things don’t seem to matter at all, but spending on inspection and regulation is actually associated with better evaluations from CEOs. This was an unexpected finding, and I’ll discuss it more below.

What about small businesses? Here are those results:

Estimate Std. Error t value Pr(>|t|)
(Intercept) -0.805 3.598 -0.224 0.82422
Taxes 0.486 0.392 1.241 0.22318
Inspection & regulation spending -12.170 8.227 -1.479 0.14826
Gas taxes 9.620 5.293 1.818 0.07795
Land-use regulation 0.235 0.147 1.597 0.11949
Tort freedom 0.078 0.407 0.191 0.84949
Occupational freedom -0.480 0.396 -1.211 0.23425
Eminent domain freedom -0.323 0.415 -0.778 0.44176
Health insurance freedom -8.801 10.890 -0.808 0.42464
Labor market freedom -36.400 11.860 -3.068 0.00421
Education freedom 2.308 10.630 0.217 0.82944

Residual standard error: 2.206 on 34 degrees of freedom
Multiple R-squared: 0.6924, Adjusted R-squared: 0.6019
F-statistic: 7.653 on 10 and 34 DF, p-value: 3.006e-06

The only two variables statistically significant at conventional levels are labor market freedom and gas taxes; however, since these variables all correlate together quite a bit, and the degrees of freedom are low, we can afford to be more generous. Land-use regulation, occupational freedom, and taxes come close to statistical significance in the expected direction (remember, positive values are “bad”), while protective inspection and regulation spending is once again in the unexpected direction and close to statistical significance. (Another reason to be generous with occupational freedom is that our indicator of that is quite noisy – lots of measurement error. We expect to improve the index in future by incorporating the IJ data.)

So how do CEOs and small businesspeople differ in the policy sources of their views on states’ policy friendliness? For starters, they both care quite a bit about labor market regulations: minimum wage, right to work, workers’ comp, family leave, E-Verify, and so on. CEOs seem to care more about taxes, but small businesspeople probably do too. Small businesspeople seem to care more about gas taxes, which I take to mean that they are more sensitive to environmental regulation and enforcement, which we don’t have very good data on, but surely correlates quite a bit with gas taxes. Small businesses also care more about land-use regulation and occupational licensing (probably), which makes sense. Construction companies and contractors are mostly smaller businesses, and occupational licensing particularly affects the self-employed. On the other hand, big business is more interested in the liability system and health insurance regulation. The former makes sense because big businesses are often the target for frivolous and “forum-shopped” product liability suits.

Now, what about those surprising results on inspection and regulation spending? It is important to remember that the results actually show that this kind of spending is associated with better business climate, all else equal. If I don’t control for any other regulatory policies, the variable is actually negatively correlated with better survey evaluations. It is also negatively correlated with Ruger-Sorens “regulatory freedom.” So what the results tell us is that businesses prefer to have regulatory agencies well funded if they are to be enforcing policies anyway. Put this way, the results begin to make sense. If I’m going to be required to get all sorts of permits for the activities I want to do, I want the government to staff the agencies well so that they can act on my applications quickly. For state governments to cut certain regulatory budgets to keep taxes low and business climate good is apparently “penny wise, pound foolish.” One might say the same for judicial system funding(*).

(*)I am put in mind of Herbert Spencer in fine populist fettle:

Far from contending for a laissez-faire policy in the sense which the phrase commonly suggests, I have contended for a more active control of the kind distinguishable as negatively regulative. One of the reasons I have urged for excluding State-action from other spheres, is, that it may become more efficient within its proper sphere. And I have argued that the wretched performance of its duties within its proper sphere continues, because its time is chiefly spent over imaginary duties. The facts that often, in bankruptcy cases, three-fourths and more of the assets go in costs; that creditors are led by the expectation of great delay and a miserable dividend to accept almost any composition offered; and that so the bankruptcy-law offers a premium to roguery; are facts which would long since have ceased to be facts, had citizens been mainly occupied in getting an efficient judicial system. If the due performance by the State of its all-essential function had been the question on which elections were fought, we should not see, as we now do, that a shivering cottager who steals palings for firewood, or a hungry tramp who robs an orchard, gets punishment in more than the old Hebrew measure, while great financial frauds which ruin their thousands bring no punishments.

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