The tricky business of measuring business climate

Forbes ranks Connecticut 36th among the states as a place to do business. Others peg it as low as 47th. On the plus side, Bloomberg places it fourth on its list of innovative states. And Connecticut ties for second-lowest business tax burden measured against productivity. Does it matter?

“There has got to a broader conversation about economic competitiveness than just saying, ‘How do they tax in Connecticut versus Florida?’ ” said Joseph McGee, vice president of the Business Council of Fairfield County.

The corporate outcry led by General Electric over the General Assembly’s 11th-hour tax increases on business led Gov. Dannel P. Malloy to capitulate Friday and propose rolling back about $100 million in business taxes in each year of the biennium.

McGee, who was the economic development commissioner during the administration of Gov. Lowell P. Weicker Jr., when imposition of the income tax eased pressure to tax business, is among those who say the bigger question for Connecticut is whether its tax policies support or subvert economic goals.

“We need to align the tax structure to economic strategy,” said Catherine Smith, the former Aetna and ING executive who’s been promoting the Connecticut economy as Malloy’s economic development commissioner for four years.

Business leaders say that was not done this year, either in the Malloy administration’s original budget proposal or the significant revisions found in the tax deal struck minutes before midnight on the last weekend of the 2015 legislative session.

Hospitals, an important economic driver, fared poorly throughout the budget process. Taxes on data processing would have tripled under the midnight tax deal, a blow to the insurance industry.

The new two-year budget boosts taxes on hospitals by more than $200 million per year. And while the industry is slated to receive three-quarters of those funds back from the state as part of an arrangement to secure more federal health care dollars for Connecticut, hospitals also watched promised reimbursements from a $350 million annual tax hike in 2011 scaled back dramatically.

Why, if the state hopes to build a bioscience industry cluster, is it imposing such deep taxes on hospitals, the Connecticut Center for Economic Analysis, the University of Connecticut’s economic think-tank, questioned in a report earlier this month.

“If health care is a growth industry, how do you best support them?” McGee said, adding that businesses are skeptical that politicians are asking these questions when they choose particular tax hikes.

When Malloy’s budget director, Benjamin Barnes, was asked by a legislative panel earlier this year why the governor was recommending further tax hikes on hospitals, he replied: “It’s like, why do you rob banks? It’s where the money is.”

Smith has been scrambling since GE, never publicly specifying how any of the tax increases affected its bottom line, threatened to move its corporate headquarters from Fairfield to another state.

“It’s been a bit of a flurry of activity,” Smith said. “I’ve been on the road quite a bit talking to business, trying to hear their concerns. I’ve been relaying conversations and messages to the governor’s office as I hear them.”

Smith said business owners and executives complained about the process as well as well as the results. Many found maddening the legislature’s habit of devising tax policy at the midnight hour.

“It’s not a moment when we’re doing strategic thinking about how taxes apply to businesses,” she said. “Overall, people have been very upset about the way the process went this year. Not a lot of transparency. It got thrown at them at the last minute. A lot of last-minute items that popped up.”

Tony Sheridan, president of the Chamber of Commerce of Eastern Connecticut, said businesses here are sophisticated enough to know that Connecticut’s high quality of life comes with a price.

“They know Connecticut is not Mississippi,” Sheridan said. “But there’s not enough communication between government and the public about how and why we are doing things.”

House Speaker J. Brendan Sharkey, D-Hamden, and Senate President Pro Tem Martin M. Looney, D-New Haven, see the legislature as open.

“I think this legislature is very sensitive to the fact we play a key role in the message that we give to the corporate community nationwide about the progressivity of our tax system, including on corporations, but also making sure that our current and future corporate partners in our state understand what we’re doing and why,” Sharkey said.

Looney, who has pressed for a unitary reporting law since he was co-chair of the Finance, Revenue and Bonding Committee 13 years ago, said the unitary approach to taxation — an underlying principal is to prevent multi-state corporations from manipulating their tax liability — is hardly exotic.

“All of our neighboring states do it,” Looney said. “In no way are we an outlier on that. It puts us, in fact, in the mainstream.”

That is true, but it also is true that how the reporting requirement is drafted can make a huge difference to businesses. The language of the version adopted never was subjected to a public hearing and was publicly unavailable until the day it came to a vote.

Smith said the process, and the renewed attention given to how Connecticut fares in state-by-state rankings, contribute to a perception that the state is unfriendly to business.

“It worries me. It piles on this perception this is not a friendly place to do business,” Smith said. “Perception is reality, and that is the challenge we face.”

Ranking the rankings

Academics differ over the most effective ways to measure business climate. GoodJobsFirst.org, a left-leaning advocacy group that monitors economic-development incentives, issued a 2013 report arguing that five of the six better-known rankings were badly flawed.

“Indeed, the underlying frame of these studies — that there is such a thing as a state ‘business climate’ that can be measured and rated — is nonsensical,” the report said. “The needs of different businesses and facilities vary far too widely. Besides, states are not the meaningful unit of competition in economic development: metro areas are, and conditions can vary more among metro areas within a state than they do between states.”

Others, including some with conservative leanings, suggest that comparing states’ total effective business tax rate, known in economic literature as TEBTR, does not give a comprehensive picture.

One reason is that business taxes are not applied equally to all economic sectors. The conservative Tax Foundation, for example, concluded in 2012 that the TEBTR on Connecticut manufacturers was among the lowest in the U.S., while the effective tax rate on corporate offices was above average.

Critics of tax rankings quickly cite an analysis prepared annually for the Council on State Taxation that contrasts taxes with the potential for profits.

That report, prepared by the global accounting firm Ernst & Young, compares state and local tax burdens with gross state product — the value of all goods and services produced. Under this approach, Connecticut ranks near the top year after year.

In other words, Connecticut’s taxes top those in many states, but the businesses here also produce much more.

The last analysis, released in August, had Connecticut tied with North Carolina as the second-most-favorable ratio of taxes-to-productivity, topped only by Oregon. Connecticut’s taxes were 27 percent below the national average by this standard.

But even the council cautions against over-relying on its study.

“TEBTRs provide a starting point for comparing burdens across states, but they do not provide sufficient information to evaluate a state’s competitiveness,” the council said.

The Connecticut Business and Industry Association argues the Ernst & Young methodology is limited in that it fails to take into account high labor, energy, transportation and other costs that – while reflecting public policy – are not taxes themselves.

Once these are taken into account, Connecticut’s business climate becomes colder, said Bonnie Stewart, the CBIA’s tax specialist.

“We know we’re not perceived as the worst place to do business in terms of taxes — at least under the old budget,” Stewart said. “While we would love to be better, being middle of the road among all states is not a bad thing,”

Stewart said Connecticut hasn’t done enough to address the other cost factors not reflected in studies like those prepared by Ernst & Young.

“Those are big issues and Connecticut has slowly been pushing itself off of the playing field,” she added. “These (new) taxes may have done it. You cannot send a tidal wave at someone and expect them to just bounce back up taking all of these factors into account. It just doesn’t happen.”

A bigger problem with the Ernst & Young methodology, McGee said, is that it is indicative of a false sense of confidence state officials have built up over time.

The problem is not so much that businesses have forgotten Connecticut’s advantages, McGee said. Rather, state government has begun to rely too heavily on the state’s tremendous per capita wealth.

“It is important to understand that we produce more per worker than most other states, and that – because we’re a high-income state – we can take on more debt,” McGee said. “But people forget there’s a limit, and now it has kind of caught up to us.”

Connecticut, which has $21 billion in bonded debt, has long ranked among the most indebted states on a per capita basis. But its per capita debt, as a percentage of personal income, now tops the national mean.

The annual payment on that debt now eats up 10 percent of the budget, and that only grows over the next two years. This only makes it harder, McGee added, for Connecticut to make crucial investments in transportation, information technology infrastructure, and education.

Tom Swan, the executive director of the Connecticut Citizen Action Group, said legislators should take a comprehensive view of how Connecticut ranks on taxes, business climate and quality of life.

“I think the measurements that matter are the fairness of the tax structure, the quality of life for the residents of Connecticut and the people that work for these companies,” Swan said. “And I think on the latter Connecticut is really, really high in every study I’ve ever seen.”

Indeed, the Social Science Research Council ranks Connecticut at the top of its “human development index,” an attempt to use big data to measure health, education and living standards.

Swan said tax equity needs to be part of the debate. While Connecticut is considered a high-tax state, businesses’ share of those taxes — 28.9 percent, according to Ernst & Young — is the lowest in the nation.

“Many people in business supported, if not accepted, passage of the income tax in Connecticut, in part because it significantly lowered taxes on business and capital gains,” Swan said. “It was part of the overall deal when that happened.”

One ranking is not challenged: Whatever the causes, Connecticut’s economic growth last year as measured by the federal government was six-tenths of a percent, placing the state 42nd among the 50 states.