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Steven Malanga
Cali to Business: Get Out!
Firms are fleeing the state’s senseless regulations and confiscatory taxes.
Autumn 2011

Last year, a medical-technology firm called Numira Biosciences, founded in 2005 in Irvine, California, packed its bags and moved to Salt Lake City. The relocation, CEO Michael Beeuwsaert told the Orange County Register, was partly about the Utah destination’s pleasant quality of life and talented workforce. But there was a big “push factor,” too: California’s steepening taxes and ever-thickening snarl of government regulations. “The tipping point was when someone from the Orange County tax [assessor] wanted to see our facility to tax every piece of equipment I had,” Beeuwsaert said. “In Salt Lake City at my first networking event I met the mayor and the president of the Utah Senate, and they asked what they could do to help me. No [elected official] ever asked me that in California.”

California has long been among America’s most extensive taxers and regulators of business. But at the same time, the state had assets that seemed to offset its economic disincentives: a famously sunny climate, a world-class public university system that produced a talented local workforce, sturdy infrastructure that often made doing business easier, and a history of innovative companies.

No more. As California has transformed into a relentlessly antibusiness state, those redeeming characteristics haven’t been enough to keep firms from leaving. Relocation experts say that the number of companies exiting the state for greener pastures has exploded. In surveys, executives regularly call California one of the country’s most toxic business environments and one of the least likely places to open or expand a new company. Many firms still headquartered in California have forsaken expansion there. Reeling from the burst housing bubble and currently suffering an unemployment rate of 12 percent—nearly 3 points above the national level—California can’t afford to remain on this path.

Illustration by Sean Delonas

California first began to tarnish its business-friendly reputation in 1974, when Democrat Jerry Brown became governor. Government’s job, in Brown’s view, was to restrain growth, not to unleash it (see “The Golden State’s War on Itself,” Summer 2010). His administration proceeded to scuttle some infrastructure spending, limit development, and expand environmental regulations. In 1977, Time declared that “the California of the 60s, a mystical land of abundance and affluence, vanished some time in the 70s.” And by 1978, the Fantus Company, a corporate-relocation firm, was ranking California the fourth-worst state for business.

Brown’s two Republican successors determined to restore California’s economic luster. George Deukmejian, who served two terms as governor starting in 1983, and Pete Wilson, governor from 1991 through 1998, worked to cut back existing regulations and reject new ones, and they trimmed some taxes and other costs of doing business, including onerous workers’-compensation assessments. Sacramento also created economic “quick-response” teams, whose mission was to persuade companies considering relocation to stay. California’s tax burden, ranked fourth-highest in the nation in 1978 by the Tax Foundation, had dropped to 16th place by 1994. “Companies are once again looking at California as a good place to do business,” a Fantus executive declared a few years later.

All that changed for the worse again when Gray Davis, Brown’s chief of staff during the late 1970s, became governor in 1999. Elected with heavy support from labor unions and trial lawyers, the Democrat signed 33 bills that the state’s chamber of commerce called “job killers.” One of the bills, for example, contributed to an increase in the payments that companies made into workers’-compensation funds from $2.30 per $100 of payroll to $6.44; the annual cost to businesses nearly tripled, from $9 billion to $25 billion. After voters booted Davis out of office in a 2003 recall election and replaced him with Arnold Schwarzenegger, the new governor promised to address the business community’s complaints. Schwarzenegger did pass one significant pro-business reform—reducing those workers’-comp fees—but otherwise made little headway. Worse, in 2006, he signed the Global Warming Solutions Act, a measure to reduce greenhouse-gas emissions that, some critics say, could boost electricity costs in the state by 20 percent or more.

As the 2000s proceeded, firms got more and more disgruntled. In a 2004 survey of California executives by the consulting firm Bain & Company, half of those interviewed said that they planned to halt job growth within the state, while 40 percent said that they planned to send jobs elsewhere, with Texas the most frequently mentioned domestic destination. Flash-forward to the present, and you’ll find bosses’ views grimmer still. In a 2011 poll by various California business groups, 82 percent of executives and owners said that if they weren’t already in the state, they wouldn’t consider starting up there, and 64 percent said that the main reason they stayed in California was that it was tough to relocate their particular kind of business. Nor do executives think that things will get better. For several years in a row, California has ranked dead last in Chief Executive’s poll about states’ business environments.

Labor groups, environmentalists, and some politicians say that such polls merely reflect businesses’ craving to get fair taxes lowered and reasonable regulations repealed. Responding to the most recent Chief Executive poll, for example, Steve Smith of the Labor Federation of California charged that it represented “little more than corporate honchos throwing around their weight to try to further strip working people of important protections that improve lives.” Similarly, though an older Jerry Brown—returned to the governor’s office in 2010—has acknowledged that California’s approach to retaining businesses may need some work, his administration considers worry about the business environment overblown. “Rhetoric aside, there are many indications that California is outperforming most of the country from an economic and productivity standpoint,” Joel Ayala, director of the governor’s Office of Economic Development, said earlier this year.

But numbers from the National Establishment Time Series database tell a more disturbing story. During the period from 1994 through 2008, the latest year for which data are available, California ranked 47th among the states in net jobs created through business relocation, losing 124,000 more jobs to other places than it gained from other places. Some argue that this exodus is inconsequential; a 2010 study by the California Public Policy Institute found that jobs leaving the state through relocations amounted to only a small percentage of California’s total job loss. But the numbers show that California isn’t creating jobs in other ways, either. It generated just 285,000 more jobs from new businesses than it lost to business failures, placing 29th in the country (first-place Florida gained 2.4 million net jobs). What’s particularly disturbing, as Wendell Cox demonstrates in “The Long Stall,” is that nearly none of those net jobs were created between 2000 and 2008, meaning that start-ups haven’t contributed to California employment for more than a decade.

The evidence also shows that California is losing the battle for new investment. From 2007 through 2010, according to a study by the California Manufacturers and Technology Association, 10,763 industrial facilities were built or expanded across the country—but only 176 of those were in California. That amounted to 4.8 facilities per 1 million people, the lowest rate of any state; the national average was more than 40. The same study found that of the nation’s $350 billion in investments in manufacturing facilities, just $8.7 billion was spent in California, a per-capita rate of investment less than one-fifth the national average.

California’s defenders argue that the state continues to incubate cutting-edge companies in places like Silicon Valley, where investment remains vigorous, thanks in part to the area’s muscular venture-capital industry. And it’s true that California entrepreneurs and early-stage firms still get one-third of all venture funding nationwide. Unfortunately, if those firms actually succeed and start creating jobs, California has difficulty cashing in. In 2007, California-based Google built a new generation of server farms not in its home state but in Oregon, employing 200 people. The following year, one of California’s most successful tech companies, Intel, opened a $3 billion production facility in Phoenix, Arizona. Earlier this year, eBay, based in San Jose, said that it would add some 1,000 back-office jobs in Austin, Texas, over the next decade.

Smaller firms have exhibited the same pattern of expanding outside the state. In fact, Silicon Valley lost one-quarter of its computer, microchip, and communications-equipment manufacturing jobs from 2001 to 2008, say Valley entrepreneurs (see “The Silicon Lining,” Spring 2010). “Every state in America is focusing on California,” Dave White, an economic-development official who tries to lure companies to Colorado Springs, told the Orange County Register last year. “It’s low hanging fruit.”

California’s suffocating regulations have a lot to do with these lousy indicators, says Andrew Puzder, the chief executive of CKE Restaurants, which operates more than 3,000 Hardee’s, Carl’s Jr., and other eateries. In a recent op-ed, Puzder called his company’s home state “the most business-unfriendly state we operate in. While we kept our corporate headquarters here, our company’s real job-creating engine has already moved.” Indeed, CKE has stopped opening restaurants in California, where the process can take up to two years because of regulations, and plans to open 300 in Texas, where a new place can debut in just six weeks. Because those two years are spent on expensive administrative work—everything from negotiating permits to filing planning documents—it can cost $200,000 more to open a restaurant in California than in Texas. And once open, a California restaurant costs more to operate, too, thanks in part to the state’s complex labor laws, including the requirement that employers pay overtime after eight hours of work in a day. California treats even service employers like CKE as if the harsh industrial conditions of the 1930s were still prevalent, Puzder complained: “It’s not like we have kids working in coal mines or women working in sweatshops.”

Many firms share this frustration with California’s regulations, and for good reason. A 2009 study by two California State University finance professors estimated that regulation cost the state’s businesses $493 billion annually, or nearly $135,000 per company. That weight, the study found, fell disproportionately on small firms and pushed California’s overall employment down by some 3.8 million jobs.

California’s regulations often utterly defeat entrepreneurs. John Bowen, the owner of an 82-year-old family-run business, King Kelly Marmalade, sold his firm to an out-of-state operator in 2007 after tiring of the ceaseless regulatory battle. At one point, Bowen started counting the government agencies that he had to deal with to run his business; he gave up when he reached 44. Bowen’s biggest woe was complying with the state’s aggressive air-pollution laws, wastewater regulations, and workplace rules. “I loved the work,” he says. “This decision [to sell] was largely as a result of excessive and oppressive government rules.”

As Bowen’s example suggests, California’s environmental regulations are particularly intrusive. Cemex, a manufacturing firm, announced last year that it would shutter its Davenport, California, plant, which employed 120 people, citing environmental regulations as one reason that the facility was the most expensive to operate of its 14 American plants. Solar Millennium, an energy company, canceled plans to build a facility in Ridgecrest, California—an undertaking that would have created 700 temporary jobs and 75 permanent ones—after lengthy delays caused by state environmental reviews, including one on the project’s impact on the Mojave ground squirrel. CalPortland, a cement company, recently shut down its 109-year-old Colton facility, laying off about 125 workers and blaming the closure on California’s environmental rules.

California prides itself on being a leader in the environmental movement, but now even some green manufacturers say that they can’t afford to stay there. Earlier this year, Bing Energy, a fuel-cell maker, announced that it would relocate from Chino in San Bernardino County to Tallahassee, Florida, where it expected to hire nearly 250 workers. “I just can’t imagine any corporation in their right mind would decide to set up in California today,” Bing CFO Dean Minardi said. Other California green firms staffing up elsewhere include Be Green Packaging, a Santa Barbara recycling company, which decided to build its first U.S. manufacturing facility in South Carolina; AQT Solar, an energy-cell maker based in Sunnyvale, which will employ 1,000 people at a new 184,000-square-foot manufacturing plant, also in South Carolina; Biocentric Energy Holdings, a Santa Ana energy company that moved to Salt Lake City; and Calisolar, a Santa Clara–based green-energy company building a factory in Ontario, Canada, that will employ 350 workers.

California seems to find innovative ways to expand environmental regulations every few years. Construction firms, recyclers, and other users of big off-road machinery, for instance, now face significant additional costs because new emissions standards will require them to replace much of that equipment. Executives at SA Recycling in Anaheim testified at a 2010 forum on business costs that their company had to spend $5 million for new parts and equipment to meet the standards. Of even broader concern are aggressive new environmental mandates, signed into law by Governor Brown, that require the state to produce one-third of its energy from renewable sources by 2020. In a state where average energy costs are 50 percent higher than the national average, businesses are understandably nervous about how such a shift will influence their bottom lines.

Yet the business community’s appeals fall on deaf ears. These days, it simply doesn’t have as much clout in Sacramento as the environmental lobby does. “The state’s environmentalists think capitalism is harmful to the environment,” says Assemblyman Dan Logue, chair of a GOP task force on jobs and the economy. “They think jobs and people leaving the state are good.”

With liberal politicians and the environmental lobby setting the tone, the state’s regulatory bureaucracy has become uncompromising, with officials frequently interpreting regulations in the most punitive manner. The owners of one small San Clemente business, Racing Optics, departed for Las Vegas after enduring harassment and threats of fines from state and local authorities over trivial issues concerning their homes, including failure to recycle water properly and to obtain the proper hazardous-waste permit for disposing of oil. Expenses for the small company, which produces laminated stickers for helmets, goggles, and vehicles, are now 20 to 30 percent lower than they were in California, the owners told the Orange County Register. Similarly, a small hair-salon chain out of Sacramento, Hoppin’ Shears, fed up with the antibusiness attitude of the state, aborted plans to open 20 new California locations and is now looking across state lines. “We eventually want 20 units, but California is too unpredictable,” firm co-owner Alice Wagner says. “Mostly it is the adversarial environment in California—like business and their owners are the nasty unwanted necessity—that we face every day when running our business.”

Illustration by Sean Delonas

Taxes are another big reason for companies to leave California. According to the Tax Foundation, California imposes the nation’s second-heaviest tax burden on businesses. True, property taxes are relatively light, thanks to the 1978 initiative Proposition 13, which capped increases. But spendthrift California politicians responded to Prop. 13 by increasing revenues from other sources—including business owners, who get socked with a crushing array of levies.

Start with the state’s high individual income-tax rates, which disproportionately affect business owners, since their incomes are generally greater than the average worker’s. Though the highest bracket, 10.3 percent, applies only to millionaires, the second-highest, 9.3 percent, starts at incomes above just $47,000 annually. By contrast, in New Jersey, another high-tax state, the top bracket of 8.97 percent doesn’t kick in until filers hit $500,000 in income. California also extracts one of the nation’s highest marriage penalties for couples filing jointly, the Tax Foundation reports. Since married couples are more likely to be business owners than single filers, the marriage penalty creates yet another disincentive for entrepreneurs to locate or remain in California.

Add to that California’s corporate income tax, one of the few that has its own alternative minimum tax feature, which excludes companies from taking deductions beyond a certain point. And California’s sales tax, the country’s most onerous, reduces demand for in-state retail sales, with residents turning instead to “out-of-state, catalog, or internet purchases, leaving less business activity in state,” the Tax Foundation notes. All this piles up. “The tax burden for a company to operate a business in California is 13 to 14 percent higher than the rest of the country,” says Gino DiCaro of the California Manufacturers and Technology Association.

Sacramento is on the prowl for yet more tax revenues, one reason why financial executives surveyed by CFO recently ranked California’s tax bureaucracy among the country’s most aggressive. This year, even as business groups pointed to the growing number of firms leaving the state, California instituted a so-called Amazon tax, a sales levy that online retailers must collect from customers. To avoid having to collect taxes, Amazon, the giant Internet marketplace where many online retailers sell their wares, immediately severed ties with California-based merchants, leaving many without any business. In July, the Contra Costa Times reported that states like Texas and Arizona were wooing these affiliates and that up to 70 had already left California to set up shop elsewhere and resume their Amazon ties, with perhaps hundreds of others contemplating doing the same. In September, California agreed to hold off collecting the tax for one year.

Defenders of high taxes often claim that such levies rarely drive a firm from a location, at least on their own. But many academic studies have shown that states with lower taxes are winning the jobs war. Plenty of low-tax spots, moreover, boast congenial lifestyles and great weather, just as California does. Take Colorado Springs, which has made poaching Golden State firms a specialty. The area’s economic-development agency estimates that 30 percent of its relocated firms come from Southern California. Dave White, the Colorado Springs economic-development official, told the Orange County Register that his area offered significant savings, including income- and corporate-tax rates less than half California’s and workers’-compensation charges 25 percent lower. The only thing that cost less in California, White boasted, was “citrus.” Owners who have fled California for Colorado Springs concur. Earlier this year, when Howell Precision Machine and Engineering, a Los Angeles County–based maker of military and aerospace parts, announced that it was moving to Colorado Springs, its owner said bluntly, “Our survival depends on our relocating to another state.”

As if California’s regulation and taxes weren’t sufficiently deadly to businesses, the state can also claim what may be America’s most expensive litigation environment for firms. The American Tort Reform Foundation recently named California one of the country’s five worst “judicial hellholes,” in part for its long history of “wacky consumer class actions.” Blame the state’s infamous consumer-rights law, which allows trial lawyers to sue firms for minor violations of California’s complex labor and environmental regulations. Abuses of the law earned California the reputation of being a “shakedown state,” with lawyers regularly sending out threatening letters in mass mailings to thousands of small businesses, demanding payments in return for not suing over purported minor paperwork violations. Outrage over the lawsuits led voters to pass a reform initiative, Proposition 64, in 2004. The new law, though, only limited the most egregious of the lawsuits by forcing attorneys, before they could sue, to show that they were representing plaintiffs who claimed to have been harmed.

One particularly troublesome source of nuisance suits is the Americans with Disabilities Act (ADA). California law allows plaintiffs to sue for damages over even minor violations of the act’s architectural guidelines for accommodating the disabled. One plaintiff has sued 1,000 businesses, mostly restaurants, and won an average settlement of $4,000. At the same time, brick-and-mortar retailers find themselves under siege from lawsuits based on an obscure provision of California labor law that requires stores to have enough seats for all employees. Wielding that law, trial attorneys have filed about 100 lawsuits, claiming damages of up to $100 per employee, against chain retailers.

California business leaders and advocacy groups have proposed various reforms to improve California’s awful business environment. At the top of the list is creating an independent commission to evaluate the impact on employment of all proposed regulations before legislators vote on them. Another idea is a requirement for new regulations to sunset within four or five years unless the legislature renews them. This would force lawmakers to revisit regulations and consider their cost after several years. Assemblyman Logue has also proposed diverting regulatory fines imposed on California businesses into the state’s general fund, instead of letting them fill the coffers of the agencies that impose the fines. Bureaucrats would then no longer have an incentive to step up fines during periods of budget stress.

California should also pursue tax reforms, including lowering the state’s top corporate and personal income rates and sharing the tax burden among more taxpayers. The sharing could be achieved by eliminating features in the tax code that target certain firms or filers, such as the alternative minimum tax on corporations and the marriage penalty on individuals. And California urgently needs to find a way to lower its sales taxes, or it will keep driving retail sales out of state.

Finally, California must reform its civil-litigation laws so that they no longer encourage frivolous lawsuits. One practical reform proposed in Sacramento would require plaintiffs to inform a business of an alleged ADA violation and then give it 90 days to fix the problem before they could file a lawsuit. Similar legislation applied to a broader range of lawsuits against businesses, such as the wave of suits against retailers for not providing chairs, would greatly improve the legal environment in the state. As Tom Scott of California Citizens Against Lawsuit Abuse recently asked: “Why can’t we just give the employee a chair rather than filing a lawsuit?”

Back in April, when California sent a delegation to study Texas’s job-development strategies, Governor Rick Perry agreed to meet with the group because he said that California’s economic fortunes were important to the future of the United States. That’s true—but then, New York State’s economic performance was once crucial to the country’s economy, too, back when the Empire State boasted a more robust private sector. America eventually passed New York by, and California assumed New York’s place as the driver of the national economy.

Now, California is in danger of giving up that role to other states. Officials in California who doubt that that can happen aren’t listening to what the state’s businesses are telling them.

City Journal thanks the Hertog/Simon Fund for Policy Analysis for its generous support of this issue’s California jobs package.

Steven Malanga is the senior editor of City Journal and a senior fellow at the Manhattan Institute.

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