States are increasingly competing with one another for jobs and capital. America’s federalism has always allowed for high degrees of regional competition compared to more centrally governed nations, but declining regional specialization and more partisan state legislatures have accelerated that competition to record levels.
Regional specialization kept Industrial Age companies in particular areas: butcheries in Illinois, car manufacturers in Michigan, and steel mills in Pennsylvania. In modern America however, regions are less specialized than they were in 1860. Declining transportation costs and the shift away from manufacturing have meant that America has an essentially national economy, with companies able to locate wherever they choose. There are glaring exceptions to this trend — Silicon Valley is in California and financial services firms are tethered to New York — but even these industries have become more mobile.
As companies have become increasingly mobile, states have also become increasingly partisan, exacerbating differences in economic policy. Thirty-seven states now have a governor of the same party that controls the legislature. This allows the party in power to rapidly make major changes in public policy.
This year alone, Kansas and New Mexico have both enacted major tax cuts and North Carolina is expected to change from a progressive, three-bracket income tax to a flat tax while also cutting the corporate income tax. Indiana and Michigan enacted right-to-work legislation in 2012, making it much harder for labor unions to organize. Texas, which has always had low taxes and right-to-work laws, goes one step further and uses the Texas Enterprise Fund to offer generous subsidies to corporations willing to relocate.
While red states are becoming more pro-business, blue states from California to Illinois are raising taxes and the minimum wage. Whatever the other merits of these policies might be, they definitely make a state less attractive to businesses. The nine states without an income tax experienced 13% job growth from 2001-2011, compared to a 7.6% national average. Since 2009, right-to-work states have created four times as many jobs as states with pro-union policies. Public policy isn’t the only reason for this discrepancy — the boom in fracking has occurred mostly in red states — but all other things being equal, businesses prefer lower taxes and weak unions.
This means that red states will continue to gain jobs and population while blue states will continue to lose them. The implications from this will shape America’s economy and politics for years to come.
The Democratic states that have been raising taxes would have a hard time cutting them even if they wanted to. These states often have billions in unfunded pension debt, creating a vicious cycle: raising taxes to stabilize the pensions in the short term, having the pension arithmetic worsened by lost population and jobs because of the tax hikes, and then needing to raise taxes again.
For their part, red states will need to cope with the large increases in population. New people mean increased demand for public services like schools, roads, and police. This in turn leads to increased expenses, forcing the states to either move away from the low tax rates that made them successful or paper over the deficits with long-term bonds and other fuzzy fiscal math.
Louis Brandeis famously wrote that states are “laboratories of democracy.” The widening distinctions between state policy will teach America an economic lesson about taxes and corporate behavior, but it will also give Republican states unexpected challenges. If the laboratories can’t handle those challenges, they may end up on fire from their own chemical compound.