You Decide: Should North Carolina Follow California Or Texas?

By Dr. Mike Walden

Both California and Texas have developed dominating economies in recent decades. The states are one and two in both size of their economy and population. If each were countries, California would have the 5th largest economy in the world, and Texas would be the 9th largest.

Yet, one of the oddities making these accomplishments noteworthy is they were achieved with very different economic models. California is a high-tax, high public spending state, whereas Texas is the opposite – a low-tax, low public spending state. Can North Carolina learn anything from these two states with their different approaches to economic development?

First, here’s some background on California and Texas and reasons why they have approached their economies so differently.

California and Texas have developed their economies around very different business sectors. Technology and entertainment are huge movers of the California economy. The state’s Silicon Valley – a region around San Jose – is the headquarters for numerous global tech firms as well as start-ups. The production of movies, TV shows and music – involving tens of thousands of jobs – has been a major component of the California economy since the 1920s.

In contrast, today’s Texas economy revolves around energy and manufacturing. Texas is a major producer of oil and natural gas, and it refines those resources into finished fuel products. A maze of fuel pipelines sprouts out from Texas to all parts of the country.

The different economies of the two states mean different workforces. California’s workforce includes a large percentage of highly educated and professional workers at the top of the pay scale, and an equally high percentage of service jobs at the lower end of the pay scale, with fewer middle-income jobs in-between. As a result, income inequality in the state is very high, with California ranking fourth among states in the unequal distribution of income.

Texas, meanwhile, has an income distribution that provides relatively more middle-income jobs than California, but also relatively more lower income jobs and fewer higher income jobs. Texas ranks below California and below the national average on income inequality.

These economic differences between California and Texas can provide an explanation for the opposite tax and public spending policies each state follows. In California, high income taxpayers in a very income-unequal state may feel an obligation to pay more taxes in order to fund more generous social programs for low-income residents. Additionally, the elite tech companies attract a highly educated workforce, one that often comes with a more favorable view of income redistribution.

With its more equalitarian workforce, residents of Texas may be less inclined to pay higher taxes to support better funded social programs. Their attitude may be more tilted to a “pull yourself up by your bootstraps” philosophy.

Currently North Carolina’s economy is more like Texas than California. Manufacturing’s share of our state’s economy is 70 percent higher than in California, but it is also 30 percent greater than in Texas. The tech sector’s share of the North Carolina economy is the same as in Texas, but the tech share in both states is 60 percent under California’s share. The split between upper income, middle income and lower income jobs is almost identical for Texas and North Carolina, and income inequality in North Carolina is slightly lower than in Texas and much below California. The biggest difference between the North Carolina and Texas economies is the large size of the energy sector in the Lone Star state.

The state fiscal policies of North Carolina and Texas are also similar. The Tax Foundation ranks North Carolina 10th best and Texas 11th best for tax systems attractive to business expansion. California is ranked 49th. Both Texas and North Carolina are below the average of state spending as a percent of the economy, while California is above the average.

Two key questions are, where does North Carolina want to go from here, and what kind of policy will take the state there? If North Carolina wants to focus on attracting businesses that are labor intensive and increase middle-income jobs, then the current policy may be the best fit. If the state wants to expand its footprint in the technology and professional areas in order to attract higher paying jobs and top educated workers, then making policy more like California’s may be appropriate.

Of course, there are debates about both the California and Texas models. Recently, California has lost some population and companies who, in part, have complained of the state’s high tax rates. At the same time, Texas’s model has been criticized for being too stingy in funding public services and relying too heavily on more regressive taxes.

Ultimately the debate about the best fiscal policy will be decided by North Carolina’s residents. If in the future more of those residents are highly educated professionals working in high-paying industries – such as technology – then North Carolina could easily migrate closer to the California model. Conversely, if most of the state’s future growth is in sectors like manufacturing, agribusiness and perhaps energy, then the pendulum could swing the other way to favoring the Texas model. Either way, the decision will be a “collective you decide”.

Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.