Stoking the furnance for factories
Manufacturers say taxes, traffic and labor shortages could stifle growth

by Jack Milligan
for Virginia Business
November 2006

Virginia may be for lovers — but is it good for businesses? Forbes.com certainly thinks so. The Forbes magazine Web site ranks Virginia first on its "Top States for Business," a list that looks at a variety of factors including business costs and labor.

But if Virginia loves business, some of the state’s manufacturers still feel jilted. Gov. Timothy M. Kaine vetoed a measure passed by the General Assembly that manufacturers say is needed to boost competitiveness. The bill would have drastically reduced the amount of time — from one year to three months — that manufacturing equipment must sit idle before it is exempt from the state’s machinery and tools tax. Twenty other states have repealed similar taxes in recent years.

In vetoing the bill, the governor said he was concerned about its effect on Virginia localities that rely on the tax for a significant part of their revenues. Last year the machinery and tools tax generated 35 percent of local revenues in Covington and 13 percent in Henry County, according to a recent study of regulatory costs on manufacturers by the General Assembly’s Joint Legislative Audit and Review Commission (JLARC).

The governor’s reasoning didn’t sit well with R.J. "Buddy" Klotz, president of Electromatics Inc., an Ashland-based company that provides control systems to a variety of manufacturers around the world. Opponents of the machinery and tools tax — including the Virginia Manufacturers Association (VMA), where Klotz sits on the board — say it discourages companies from modernizing their facilities because it would increase their tax liability. That’s a problem for Klotz because his company helps manufacturers automate their plants. "I have some very strong feelings about the impact of the tax on manufacturers," says Klotz. "It has a negative impact on our products and our bottom line."

Virginia’s manufacturing sector is growing smaller, despite recent bright spots such as the Swedwood North America plant planned for Southside Virginia (page 5). JLARC says that the state’s factory work force shrank from 407,200 in 1992 to 296,000 today. From November 2005 through June of this year, according to the Virginia Employment Commission, plant closings by Dan River Inc. and Dana Corp. cost the state nearly 2,000 jobs. The closing of Ford Motor Co.’s truck plant in Norfolk will put another 2,500 workers on the street next year.

Taxes are just one of the issues worrying Virginia’s manufacturers. They also wonder whether Virginia will have enough skilled workers to run the highly automated plants of the future. And they watch the state’s increasingly congested road system with growing alarm — particularly in light of the failure of the Virginia General Assembly to agree on a comprehensive transportation funding plan at the conclusion of the special legislative session in September. But manufacturers like Klotz are particularly bothered by the machine and tools tax because — according to an Ernst & Young study commissioned by the VMA — Virginia’s manufacturers have a higher effective tax rate than companies in other business sectors. (Effective tax rates are found by dividing state and local property taxes by the value of business property.)

Why worry about manufacturing at all? For one thing, many manufacturing jobs tend to be higher paying than service-sector jobs. The National Association of Manufacturers in Washington reports that manufacturing jobs pay an average of $63,000 per year. Large industrial plants also tend to create opportunities for growth at other companies that supply them with parts and materials in an era of just-in-time inventory. "That’s why we covet manufacturing jobs in this state," says state Sen. Frank W. Wagner (R-Virginia Beach), who sponsored the machinery and tools tax reform measure in the Senate.

The Ernst & Young study compared the tax burden of Virginia manufacturers with other states and other industries. The study examined the effective property tax rates for five Southeastern states that Virginia frequently competes against for industrial prospects — Alabama, Georgia, Kentucky, North Carolina and South Carolina. Only in South Carolina was the rate higher than in Virginia. Just as vexing to Virginia manufacturers was the study’s finding that they have a higher effective tax rate than other sectors such as retail and professional services. The study blamed the disparity in part on taxes that manufacturers pay on machinery and tools and also on the comparatively high taxes that manufacturers pay on electric utility services because they tend to be heavy users of power.

The JLARC regulatory study also identified the machinery and tools tax as a major sore spot for manufacturers. JLARC concluded that Virginia’s job losses are largely the result of global factors, such an international competition and changing technology, rather than state taxes or regulations. But in comparing the state’s manufacturing regulations with Pennsylvania, Maryland, North Carolina, Tennessee and Georgia, the agency found that Virginia was the only one that allowed localities to set the evaluation basis and taxation rate for machinery and tools. JLRAC says that the tax, which generated $194 million last year, probably is not the driving factor in a company’s decision to relocate or expand. But the agency says inconsistency in the way localities apply the tax has created headaches and additional regulatory cost for companies with more than one factory in the state.

The legislature’s attempt to reform the machinery and tools tax, sponsored by Wagner and Del. Christopher B. Saxman (R-Staunton) in the House of Delegates, would have revised some of the law’s definitions and reduced the timeframe for tax liability on equipment. But there was no phase-in period, so the law would have taken effect, and reduced local tax revenue, immediately. "That’s not good public policy," says Theodore J. Settle, director of the Office of Economic Development at Virginia Tech.

Altering the machinery and tools tax ran into strong opposition from communities around the state. "Changing taxes at the local level has to be done through negotiation and compromise," says Michael Edwards, deputy director of legislative affairs for the Virginia Association of Counties, which opposed the measure.

According to Edwards, each locale has to develop a tax policy that fits its community and economic resources — including any manufacturing facilities that might be located there. "Changes to business tax policy at the local level do affect other taxes," Edwards says. "If you squeeze one end of the balloon, the other end gets bigger." In other words, cutting the machinery and tools tax could lead to tax increases in other areas.

Settle does not have the same visceral reaction to the machine and tools tax that many Virginia manufacturers do. "There does appear to be an extreme fixation on the tax, probably because it’s an irritant to some," he says. But he disagrees philosophically with any tax that would specifically penalize manufacturers for expanding their operations. "You don’t want to tax things that you want more of," he says.

A second tax reform bill could end up on Kaine’s desk during the next legislative session in Virginia. Allan Sharrett, the VMA’s director of government affairs, says the measure still enjoys broad bipartisan support in the legislature, and Kaine recently directed Pat Gottschalk, the state’s secretary of commerce and trade, and Department of Taxation Commissioner Janie E. Bowen to try to work out an agreement between the manufacturers and local governments. "The state is acting as the honest broker to reach some sort of compromise," says Gottschalk. "I’m hopeful that the parties will work it out, but I can’t predict the future. We have had some pretty good discussions going back and forth."

From the viewpoint of many Virginia manufacturers, there’s more to worry about than just the state’s tax policy. Some experts are concerned that Virginia’s well-documented transportation woes could stymie the growth of manufacturing. "If we don’t get to work on our transportation problems, Virginia will be a less desirable place to locate," says Wagner. Years of growth in Northern Virginia and the Tidewater region have created two of the most heavily congested areas in the country.

But Secretary of Transportation Pierce Homer argues that Virginia has several transportation-related assets that are of great importance to manufacturers, including Washington Dulles International Airport and the Port of Virginia. Homer also points to such important initiatives as the Heartland Corridor Project, where Norfolk Southern Corp. and the state are working together to create an efficient intermodal rail route from the Port of Virginia to Columbus, Ohio, which will allow for the double-stacking of cargo containers. "One of our biggest advantages in Virginia is direct access to rail," says Homer.

Manufacturers also wonder where the skilled workers of the future will come from. For his part, Settle believes this issue might do more to dampen the growth of manufacturing in Virginia than the machine and tools tax. "Manufacturers complain a lot more about finding skilled trades people than about the tax," he says.

According to the VMA, Virginia will need 45,000 skilled workers during the next 10 years to replace those who are expected to retire. The group plans to work with the Department of Commerce and Trade and other state agencies to conduct a study on the demand and supply of manufacturing skilled trade jobs in the state. An important component of any work-force initiative, Settle says, is educating high schools and young people about the value of manufacturing jobs. Unlike the smokestack industries of yesterday, many plants today are highly automated and require a high degree of technical skill to operate. "It’s not the plant your grandfather worked in," says Settle. This is one area where Settle believes that the state could make an important contribution.

Recent initiatives show that Virginia is not ignoring its manufacturing bases. Last year the state created the Manufacturers Development Commission, chaired by Wagner (Settle is a member, too), to look at issues affecting the state’s manufacturing companies.

Judging from Forbes’ recent ranking, Virginia is viewed by outsiders as an attractive business state. A few years ago, Klotz considered moving his company to Charlotte, N.C., after opening an office there. But after much study, he decided to stay put. "Overall, our opportunities were greater in Virginia than in Charlotte," he says.