RealClearMarkets: U.S. States Must Team Up If They Want to Compete With California

Businesses say they are fed up with California’s regulatory and tax burdens. The Wall Street Journal editorial page notes that the number of companies leaving California “has exploded.”  Many claim California will collapse from self-imposed tax and regulatory burdens. Is it 2021? Try 2011.

For the next decade, California dominated every state in the country in attracting emerging businesses, receiving over 50% of all U.S. venture capital investment in 2020.  Unless something changes, states across the country will wake up in 2031 and realize their local businesses have again been disrupted by startups based in California.

The solution is for states to stop competing alone. Instead, states should be as disruptive as the companies they wish to attract by joining together around a coordinated policy framework. By implementing cross-state regulatory harmonization, states can combine a common-sense regulatory environment with a market larger – and more appealing – than California. The result would create an attractive workforce pool and opportunities to grow state and regional economies.

Businesses endure higher levels of taxation and regulation for access to California market size (39 million people), talent pool and proximity to investment capital.  Despite California’s tax and regulatory drawbacks, individual state efforts to compete for start-ups have been unsuccessful.

Texas’ experience demonstrates the challenge of competing with California.  While venture capital investment levels in Texas may have doubled from $1.5 billion to $3.0 billion over the past decade, California’s venture capital investment over the same period quadrupled from around $13 billion to over $60 billion.  This means Texas’ share of U.S. venture capital investment actually fell by half, from around 5.5% in 2010 to 2.7% in 2020.  If Texas can’t keep pace on its own, what other state can be successful?  Clearly states looking to compete need a different strategy.

States should stop viewing their competition with California as an individual contest, and start joining forces. If Alabama, Arizona, Florida, Georgia, Indiana, Ohio, Tennessee, and Utah were to coordinate their regulatory policies, they would create a market of 75 million people. Add 13 more states (including Texas) with one party (Republican) control of both the legislature and governor’s office, and the market would be over 130 million. A market like this that crosses multiple geographic regions with aligned regulations could become the best place in the country to launch and scale a business.

Such a strategy gives entrepreneurs the best of both worlds: a large addressable market, and a low-friction regulatory environment.  For example, reciprocal licenses for money transmission or insurance would enable relatively seamless expansion across jurisdictions. Coordinated employment regulations would provide more certainty for launching gig economy companies. Other examples include uniform data breach standards, or consistent treatment for cryptocurrency.  The key will be for states to jointly become first-movers in response to innovation, rather than acting in response to a California data-privacy law or a New York bitlicense.

Without such coordination, states that believe they have created a low-cost regulatory environment may actually have created a high-cost regulatory environment because of most states’ relatively small population.  Even if each state individually has a light regulatory burden, the regulatory friction from obtaining multiple licenses and complying with differing regulatory regimes over multiple states to access a market of 39 million people may exceed the regulatory burden of operating in California.

Efforts to coordinate laws across 50 states often fail. Here, the task is simpler because a subset of the 50 states can create a meaningful market.  Moreover, a number of states have already shown a willingness to coordinate. The Trump Administration launched a little-known effort, the “Governor’s Initiative on Regulatory Innovation.” This initiative focused on deregulation, with governors in 25 states promising to cut regulations in similar volume to the Trump Administration.  If 25 states can agree to cut regulations, then a portion of those states can agree on converging regulatory requirements, recognizing each other’s licenses, and leading on innovation policy.

Initially, interested state economic development departments could jointly issue a request for information to innovators and receive input on the most important areas for regulatory convergence.  States could also encourage their state innovation associations to work together by identifying hurdles to cross-state expansion. To build the foundation for future reform, states could stop publishing their statutes and regulations in .pdf and instead utilize formats enabling simpler automated comparisons.

Acting now could allow states to take advantage of remote work to neutralize incumbent states’ labor pool advantages.  McKinsey estimates that remote work will increase by 4 or 5 times post-Covid. Creating reciprocal tax offsets and streamlining payroll regulations with other states could lower costs for businesses to utilize a multistate remote workforce.

Many states recognize the need to attract emerging businesses.  Acting together, however, can empower states throughout the country to lead in launching the next generation of innovative companies and capture the attendant economic growth and opportunities for their citizens.

Mr. Watkins is a Managing Director at Patomak Global Partners, and the former head of the Office of Innovation at the Consumer Financial Protection Bureau.