The high-stakes game of corporate relocation can have a huge economic impact on the bottom lines of both companies and states.

Even the threat of relocating, such as the subtle one fired off by Illinois-based Caterpillar (CAT) last week, can have a lasting impact on profits and recruitment efforts.

While states vying to lure a company to relocate its headquarters inside their borders typically offer attention-grabbing tax breaks and other incentives, savvy CEOs should resist basing their decision on those fleeting goodies and give greater weight to a location's long-term ability to attract and retain talent.

“Recruitment and retention gets to the heart of what the company is. If you don’t keep talented people, you can’t make any money to pay taxes on,” said Mark Sweeney, senior principal at McCallum Sweeney, a site selection consulting firm.

Moves within the U.S. have become even more important as new laws put on the books by Congress have largely taken the option of fleeing to more tax-friendly countries off the table.

Even the threat of relocating, such as the subtle one fired off by Illinois-based Caterpillar (CAT) last week, can send shockwaves through a state.

Doug Oberhelman, the CEO of Caterpillar, appeared to raise the possibility of leaving Peoria, Ill., in a letter last week to Gov. Pat Quinn that leaked to newspapers.

“I want to stay here," Oberhelman reportedly said in the letter, which expressed concern about the state’s plan to raise personal income taxes to 5% from 3% and corporate taxes to 7% from 4.8%. "But as the leader of this business, I have to do what's right for Caterpillar when making decisions about where to invest."

Premium Put on Talent

If Caterpillar was seriously considering a move, relocation experts would list cities that make the most economic sense, especially on the labor side. The focus on talent in corporate relocation boils down to a city’s ability to either supply the workers needed to operate the headquarters or the likelihood employees and job candidates will want to move there.

“This is a long-term decision. You need to be in a market that can support your skill set,” said Mark Seeley, senior managing director of CB Richard Ellis’ Labor Analytics Group. Seeley notes that labor typically represents 70% to 80% of the operating cost of the headquarters.

Companies weigh a slew of attributes used to measure each location’s quality of life, including housing affordability, commuting conditions, local education, safety and recreational activities.

“Everyone thinks their quality life is great and they say that in all sincerity. But there is a difference in quality of life between a small town in South Dakota and Chicago,” said Sweeney, whose firm is based in Greenville, S.C.

Despite receiving tempting incentive offers from competing cities, vacuum manufacturer Oreck based its decision to move to Nashville from a New Orleans suburb in 2008 on talent, not tax breaks.

“First and foremost is the presence of good people. That’s by far the most important criteria,” said Bill Fry, chairman of Oreck.

Dubbed the Music City, Nashville has a population of about 625,000 and has successfully lured a number of other companies to relocate their headquarters in recent years, including Nissan North America, wireless insurance provider Asurion and Caremark, which was later acquired by CVS, forming CVS Caremark (CVS).

“They leveraged the fact they are a city, but not a monster city like Atlanta or Chicago,” said Sweeney.

It helps that Nashville resides in a state with no state income tax except on dividends and interest income. Plus, it has its own international airport that is served by 11 carriers and handles about 9 million passengers a year and Nashville is just a few hours away from Memphis, the home of shipping giant FedEx (FDX).

Proximity to major transportation hubs may be the second most important factor when companies weigh relocation sites. Being close to airports can cut down time and costs for visiting clients or suppliers and can be used as a selling point to prospective employees.

“It is difficult for headquarters projects to pull themselves away from major hub airport cities,” said Sweeney.

Tax Incentives Help Seal the Deal

A number of states have become very aggressive in their attempts to lure companies to relocate, with some governors using the incentive packages as a last trump card to finalize the move. According to CB Richard Ellis, the most aggressive states include Texas, Florida, Missouri, New Jersey and Connecticut.

Incentives can include a variety of tools but often fit five main options: corporate income tax credits, payroll rebates, property tax abatements, upfront cash grants and deal-closing funds.

The amount of incentives offered in relocations often depends on how many jobs are expected to be created, the average salary of new jobs and how much capital is expected to be spent on facilities, equipment and furniture.

While they can be effective, not everyone considers incentives to be good policy.

“It’s not good for the overall health of the state’s economy,” said Kail Padgitt, a staff economist at the nonpartisan Tax Foundation. “Businesses should go where they are most efficient at producing, not because they are given tax incentives.”

Stuck With Lofty U.S. Tax Rate?

Companies based in the U.S. tend to be much more heavily taxed than many of their global peers as the 2010 U.S. corporate tax rate, including state tax, stood at 39.2%. By comparison, Ireland’s corporate rate stands at 12.5% and Switzerland’s is just 21.17 %, according to the Tax Foundation.

U.S.-based companies also have to pay U.S. taxes on income of their foreign subsidiaries, something most countries don’t require.

“There is no other major industrial country that has such a system,” said William Dantzler, Jr., head of White & Case’s global tax practice. “It clearly is a competitive disadvantage. I think everyone would admit that. The harder question is what should be done about it.”

Due to changes in the tax code over the past decade, major U.S-based companies hoping to lower their tax bill no longer have the option of moving to a more tax-friendly country like Luxemburg or Belgium. These new rules make it prohibitively expensive for companies to move their headquarters unless their shareholders have drastically changed, typically in the wake of a merger or acquisition.

“Flipping a switch and moving to Bermuda…has virtually been eliminated,” said Daniel Dunn, head of the tax group at Dechert. “It almost doesn’t happen.”

Banding Together

In some U.S. industries, competing companies tend reside in the same geographic region of the country, creating clusters of companies that hold sway with local lawmakers and attract capable workers who see a variety of potential employers. 

The most obvious example is the heavy concentration of technology companies like Google (GOOG) and Intel (INTC) in Silicon Valley. There's also a big base of drug makers like Pfizer (PFE) in the Northeast and auto makers in Detroit. Likewise, many media and financial giants reside in New York and credit card companies tend to be based in North and South Dakota. 

While banding together certainly has its advantages, it can also cause workers to leap frog from one company to another, forcing employers to overpay for labor. 

“At a certain point it becomes overheated and oversaturated with employers looking to hire similar skill sets," said Seeley.

State Corporate Income Tax Rates, 2000-2011

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