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How Cities Can Take Care of Businesses

Uncovering problems with tax codes and licensing regimes

Anthony Randazzo
March 17, 2010

The Internet and globalization have both made it possible to operate a business from virtually anywhere and still serve a wide range of customers. Most firms no longer need to be located in downtowns or large financial districts. This flexibility has made it easier than ever for businesses to leave cities that have an unfavorable tax and regulatory climate. American cities in decline are largely victims of their own failure to take a fresh look at how the economy continuously repositions itself in an information-driven, globally competitive world market, and respond with policies that encourage entrepreneurial investment, private sector growth, and local consumption of goods, services, and housing.

What are the best ways that city politicians can take care of the job-creating and tax-producing businesses that are at the heart of any flourishing metropolis? The shortest answer is to keep taxes and licensing requirements simple, fair, and predictable.

Taxes

Cities with heavy tax burdens put themselves at a competitive disadvantage with more relaxed localities. Taxes always create disincentives for business growth and expansion. Cities with simple, limited tax structures are much more successful at encouraging business development. Local leaders should be aware of how various taxes can weigh down economic growth. These include:

Business Taxes. The higher the business tax burden—whether through income taxes on the self-employed, corporate taxes, or others—the less likely a business is to open in a city, or remain in a city. Business taxes also place a higher tax burden on low-income individuals, as any business tax is ultimately passed on to the consumer in the form of higher prices.

Local Sales Taxes. Increased costs from sales taxes are a deterrent to consumption because they make goods and services more expensive. Cities with lower sales taxes in competing areas will draw business away from cities with higher rates. So sales taxes can also hurt business.

Property Taxes. Cities often use property taxes as their main source of revenue. But the higher the property taxes in business districts, the greater likelihood that a business will move to a nearby area with a more competitive structure. Residential property taxes also impact economic growth by discouraging individuals from living close to cities and thus closer to small businesses that cater to local residents—like bakeries and barber shops. And commercial property taxes assessed on physical improvements to land—such as construction of a new building or an addition to existing property—are often a deterrent to entrepreneurial activity.

Fees. Localities often times use the word “fee” when the word “tax” is just as applicable. Starting January 1, 2010, Washington D.C. began charging a five-cent tax on plastic bags used at grocery stores to fund a river protection program. Whether called a fee or not, this is an additional charge each purchase for consumers. And the tax is likely to drive some business to nearby Maryland and Virginia, where shoppers can avoid the extra charge.

Licensing

Entrepreneurism is a vital part to economic growth in cities. Local leaders should work to limit red tape, simplify the regulatory process, and do everything possible to create a hospitable licensing climate for business.

Occupational Licensing. Occupational licensing laws are billed as a means of protecting the public from negligent, unqualified, or otherwise substandard practitioners, but in reality they are usually a means of utilizing government regulation to serve narrow economic interests. By banding together and convincing governments to impose new or stricter licensing laws, existing practitioners (who typically are exempted from the new laws through grandfather clauses) can raise the cost of doing business for potential competitors. These barriers to entry reduce competition, allowing the existing practitioners to keep prices and profits higher than they otherwise would be in a truly free market.

Permitting and Inspection Barriers. Every city has permitting and inspection procedures. But some cities require more permitting and oversight than others. Excessive permitting leads to lost time, energy, and money—all reasons why businesses might leave oppressive cities.

Business Operations Regulations. Entrepreneurs often face challenges getting all the right paperwork required for setting up a new business done property because of a lack of coordination between city agencies. Ideally, cities should have a single department or agency that could provide “one-stop” permitting and licensing along with all relevant information on zoning, inspections, and taxes for small businesses. The easier it is to start a business or expand a business the more vibrant the local economy will be.

Eminent Domain and Regulatory Takings. Local governments have the power of eminent domain, which is suppsed to be used sparingly and only for the general good of the public. An example of appropriate use is when it might be necessary to expand utilities facilities or police station. Cities should avoid abusing the power of eminent domain to give prime real estate to choice business ventures on the hope that the new companies will provide more tax revenues. This might attract one-time business investment in a community, but is creates disincentives for small businesses to start up for fear of a violation of their property rights.

Policies that focus on making entrepreneurship easy and affordable will be milestones in leading a city to having a thriving economy. Reducing the tax burden on small businesses will encourage new types of stores, services, and production facilities to come back in, or stay in, city limits. Curtailing red tape and licensing procedures will also make cities more attractive to business development, helping localities take great strides towards fostering vibrant and sustainable economic growth.

Anthony Randazzo is director of economic research at Reason Foundation. This article originally appeared at Reason.com. This is a companion piece to the documentary series Reason Saves Cleveland With Drew Carey: How to Fix The Mistake on The Lake And Other Once-Great American Cities. . Go here for a full episode guide and more.


Anthony Randazzo is Director of Economic Research


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