California's Problem Is There's No Plan B
On the macro level, California is finally coming out of the Great Recession, but on a micro level, this recovery is precariously balanced on the shoulders of one region. If something were to happen to the Silicon Valley-Bay Area region, the Golden State currently has no Plan B. This isn't meant as a critique of the other regions of California, but rather a critique of how Sacramento has largely been blinded by the macro-level data to the detriment of exploring ways to spur growth in a more diversified manner.
Just like anywhere in the world, there are many potentially serious policy threats looming under the surface that could inhibit the Silicon Valley-Bay Area regions' competitiveness into the future. And there is strong evidence that these issues are already starting to have an impact. Between 2008 and 2014, 33% of the businesses that left California came from the Silicon Valley-Bay Area region; moreover, 8 of the top 15 business disinvestment municipalities are located within the Silicon Valley-Bay Area region. This is largely because the tech industry experienced the third most disinvestment during this time period.
When businesses determine where to start and where to expand, they take into consideration a series of factors, particularly any local taxes and regulations that may impact their bottom line.
Business taxes overtly hamper the bottom line: In California, non-pass through businesses could face three different types of business taxes. First, California's corporate income tax, at 8.84%, is the highest west of the Mississippi River in the continental United States. Second, the franchise tax - commonly defined as the tax paid "simply for the privilege of doing business in the state" - is 1.5% of the corporation's net income with a minimum amount of $800. Thus, even if your business is actually operating at an income loss, you still owe California $800 just for the right to do business within the state. Finally, some businesses are subject to a 6.65% alternative minimum tax which aims to reduce tax avoidance.
But in California, over 55% of the total private sector is employed by pass-through businesses (i.e. sole proprietorships and partnerships). These businesses are taxed via the personal income tax and California has the highest combined federal and state top marginal income tax rate in the nation for pass-through businesses.
In order to legally minimize their tax exposure, mature firms must employ legions of tax accountants and lawyers. Most are successful, but at a cost of employing individuals that don't necessarily promote the business' mission. Start-ups, however, don't have the luxury of hiring corporate talent to avoid taxes. Moreover, start-ups tend to be pass-through businesses, which impacts their bottom line substantially. And the other areas Silicon Valley-Bay Area is competing with - Seattle, Austin, Raleigh, Nashville, Salt Lake City - are located in states with far better business tax climates, making these business tax issues even more pronounced.
Business regulations opaquely hamper the bottom line: The cost of taxes is easy to decipher. But the cost of business regulations doesn't appear in a line item on a business' balance sheet. Regulations create barriers to entry for start-ups and force mature companies to hire even more non-mission focusing employees (like compliance attorneys). Business regulations are among the biggest challenges for Silicon Valley companies with the California Environmental Quality Act (CEQA) and wage/hour rules being the two most onerous.
CEQA mandates that any development project must first assess the potential environmental impacts of the project and develop a mitigation plan to avoid those impacts. It includes a private right of action clause, which gives anyone - regardless of standing - the right to sue to ensure compliance. Naturally, this creates a plethora of litigated delay ensuring any proposed project is trapped in a legal quagmire. And despite Silicon Valley CEOs naming housing affordability and traffic congestion as among the top cost of living challenges for their employees, the most common private and public projects targeted by superfluous CEQA litigation are private housing projects and public transit projects.
California's wage and hour rules make working in the Golden State enormously rigid, which is at odds with Silicon Valley culture. These rules, developed for 20th century labor conditions, don't fit nicely into the new economy's work-life paradigm. Among the least flexible is California's strict maximum hour rule. Not only does California have a maximum 40 hour work week, California law mandates a maximum work day of 8 hours. Thus, overtime is trigger when working in excess of 8 hours per day, in addition to in excess of 40 hours per week. This means that if an employee wanted to work four 10 hour days, a Californian employer would have to pay that employee 8 hours of overtime, even though the individual still only worked 40 hours in that week. Not only does this cost employers, but it also impedes employees and employers from negotiating mutually-beneficial working terms.
At the end of the day, a business must consider its bottom line (otherwise, it has to close its doors) and that is where taxes and regulations play an important role. As other regions in and outside the United States focus their attention on attracting Silicon Valley-Bay Area companies, these issues are only going to become more dominant.
