States with Better 'Business Climates' Also Have Higher Inequality

There's a clear connection between economic inequality and low-tax, pro-business policies.

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REUTERS/Chip East

Economic inequality has risen substantially in the United States over the past several decades, but its rise has been uneven across the 50 states. According to my own analysis here on CityLab, more than half of states—26, plus Washington, D.C.—saw inequality increase at a higher rate than the national average between 1979 and 2012.

Inequality has mainly been tied to big economic shifts like globalization, technology, and rising returns to capital. Some commentators have also highlighted the role of national policies like changes in the income tax or the rate of taxation on capital gains. But what if changes in policy at lower levels of government have contributed to the rise in income inequality as well?

A new study by economists David Neumark and Jennifer Muz of the University of California, Irvine examines the effects of state policies meant to promote better business climates on inequality. It looks at two types of business climate policies: policies that seek to spur growth by lowering business costs and those that seek to do so by improving quality of life. They examine the effects of these two policy strategies by using widely cited “business climate” indexes developed by organizations such as the Cost of Doing Business Index, the State Business Tax Climate Index, and the U.S. Economic Freedom Index, which proxy for cost reduction strategies, and “quality of life” indexes like the State Competitiveness Index, the State New Economy Index and Development Report Card for the States.

Neumark and Muz note that prior research has found a positive relationship between economic growth and business climate indexes—indicating lower-cost, lower-tax business climates are good for economies. But previous work has found little connection between economic growth and index results based on productivity or quality of life. They examine the effects of these two broad types of business climates on inequality between 1992 and 2008. (They stopped at 2008 to avoid the skewing effect of the Great Recession.)

To gauge inequality, the study used standard measures of income differentials based on the differences between the 10th, 50th and 90th percentiles of the income distribution, as well as state poverty rates. The researchers also included a range of variables that other studies have found to be associated with economic growth, such as proximity, density and mild temperatures.   

The big takeaway: There is a clear connection between economic inequality and low-tax, low-cost state business climates (or, more accurately, business climate indexes based on those factors). As they put it: “The same tax and cost related indexes that are associated with higher economic growth are also associated with increases in inequality.” 

Neumark and Muz found a more ambiguous relationship between inequality and “quality of life” factors, discovering “little consistent evidence that policies captured by productivity/quality of life indexes are associated with moderate economic inequality.” They note that this does not mean such policies are associated with less inequality; instead, their findings suggest that policies that seek to improve a state’s quality of life won’t necessarily lead to a reduction in inequality.

The researchers qualify their findings, noting that they are based on business climate indexes that strive to capture broad policy strategies and approaches, as opposed to rigorous causal analyses of specific state policies. Still, they conclude that their findings may still be of considerable value given that state and local policy makers—not to mention voters and citizens—tend to think in terms of and make decisions based upon these broader characterizations.

Neumark and Muz emphasize that state and local leaders should keep in mind the very real tradeoff between economic growth and inequality. “[P]olicymakers – and society at large – have to make some tradeoffs when choosing policies affecting taxes and the costs of doing business; the policies that enhance growth are also associated with more rapidly increasing inequality.”And they continue: “Moreover, there is some evidence that the tax-and-cost-related policies that spur greater inequality and faster growth are less generous welfare and transfer programs.”

Their findings are underscored by of my own analysis of the growth in state inequality between 1979 and 2012, which I wrote about here on CityLab in May. I found inequality to be highest and to have grown the most in states that have most aggressively implemented low-cost strategies and right-to-work statutes.  In a detailed study with Charlotta Mellander, “The Geography of Inequality,” published in Regional Studies last year, we found additional evidence of the role that policy plays in inequality, finding inequality at the metro-level to be associated with lower tax rates and lower rates of unionization, as well as poverty, race and skills.

Rising inequality is clearly the result of big structural forces that have and will continue to affect our economy. But it is also the result of policy choices at the national and state level over which we have control.

 

About the Author

  • Richard Florida is Co-founder and Editor at Large of CityLab.com and Senior Editor at The Atlantic. He is director of the Martin Prosperity Institute at the University of Toronto and Global Research Professor at NYU. More
    Florida is author of The Rise of the Creative ClassWho's Your City?, and The Great Reset. He's also the founder of the Creative Class Group, and a list of his current clients can be found here