Editor’s Note: As part of our continuing series of in-depth reports on reform choices in Lansing, this story examines some of the $35 billion in total state tax breaks Michigan provides this year. Legislators are studying whether to scale back such breaks to solve both short- and long-term budget shortfalls. The full list of current state tax breaks is available here.

By Melissa Preddy

While Michigan leaders debate budget cuts and appropriations in an ongoing struggle to stretch dwindling state resources, the flip side of the budget – tax breaks for individuals and businesses that force the state to give up revenue it could otherwise spend – should be getting more scrutiny, some analysts and lawmakers say.

Some breaks offer direct cash-flow benefits to the general public. The sales tax exemption on groceries and prescription medications  saves money for consumers but will cost the state nearly $1.7 billion in foregone revenue this year, according to estimates from the state Treasury Department.  And if seniors paid taxes on Social Security income state coffers would take in an extra $53 million, along with $55 million if parents gave up the child credit.

Other tax breaks – some call them loopholes — benefit specific private-sector industries – like private sports venues, retailers, hybrid engine developers and movie makers — in hopes of stimulating employment and economic development.  The Michigan Brewing Co. in Webberville is retooling to ferment Kid Rock-branded beer. It will get a credit of $90,000 this year, and more than $700,000 over seven years.

Critics say the state’s lawmakers are thoughtlessly doling out tax credits which haven’t proven to reap jobs and economic growth.

“But it would be pretty radical to get rid of them all and start from the ground up,” said  Alex Rosaen, a consultant with Anderson Economic Group in Lansing.  Suddenly taxing prescription drug sales or eliminating the Earned Income Tax Credit for low-wage workers “would pull the rug out abruptly and be a sudden, huge change for a lot of people.”

Formally dubbed “tax expenditures,” these credits, deductions and other breaks were  expected to cost the state $35.8 billion in fiscal 2009.  (That estimate could be high, however, since many credits are predicated on things like income and sales, which are not as robust in 2009 as was predicted when estimates were drawn up in early 2008.)

In fact, on paper the breaks are greater than what the state does take in, which was estimated to be $24.2 billion this year.  Economists do caution that the ratio is somewhat misleading because many of the tax breaks are tied to federal tax policy, such as the Earned Income Tax Credit, or they are items that from a political standpoint seem untouchable, like the Homestead Property Tax Credit. So the notion that tax expenditures reflect more than $30 billion down the drain on frivolous or favoritism-driven programs is wrong.

Bottom line, however, expenditures are revenue the state could charge taxpayers under existing law, but doesn’t, once lawmakers deem that citizens are better served by the results of the tax breaks than by what the state otherwise could spend the income on.

At least, that’s the theory.  For example, the rationale behind the tax credit for the Kid Rock beer was that the retooled brewery will create new jobs, and eventually the new brews will generate more tax dollars to make up for the credit.  James M. Hohman, analyst for the Mackinac Center (a conservative think tank) contends that bolstering one such business with public dollars creates unfair competition for other Michigan breweries and that historically, such credits granted by the Michigan Economic Growth Authority (MEGA) often do not result in the job creation used to justify the credits in the first place.

And recently, another form of tax expenditures – refundable credits for film makers – has been drawing skepticism from analysts and lawmakers.  Under a 2008 Michigan law, movie producers are eligible for a refund of up to 42 percent of the dollars they spend in the state – even if that exceeds their actual tax liability. So in essence, the state can be paying movie makers to work here.

Sen. Nancy Cassis, R-Novi, chairs the state Senate Finance Committee.  She has been vocal in her skepticism about the film credits and is drafting legislation to cap such incentives as early as the start of the 2010 budget year on October 1.

“These are generous grants that are being subsidized by other taxpayers,” said Cassis. “This is a state that is laying off state police, cutting $110 per student in school funding and cutting revenue sharing to local government – and yet subsidizing movie studios?”

The state film office counters that in its first nine months, the film-making incentive program resulted in 35 movie shoots and $125 million in spending, compared to three films and $2 million in spending the previous year.  So far in 2009, four films have been completed, five more are under way and eight are in pre-production, said Michael Shore of the Michigan Economic Development Corporation.

Tax breaks in tough times

The debate about tax expenditures is  particularly relevant now when the state is shedding jobs, real estate value and tax revenue at an accelerating rate. So far this year, state revenue from income, property, sales and business taxes is  well below projections, and Governor Jennifer M. Granholm has issued executive orders slashing nearly half a billion dollars from the state’s 2009 spending budget. Workers at a variety of agencies are taking required days off without pay, and state-run services ranging from respite care to prisons to parks will get less funding than expected this year.

Meanwhile, “silent spending” via tax credits, incentives and deductions continues unchecked.

Even as the State Police takes a $15 million hit in 2009 and community health dental services are cut by more than $1 million, the privately owned Michigan International Speedway will get up to $650,000 this year in tax credits for upgrades and infrastructure improvement. The speedway also can write off 50 percent of the cost of traffic and pedestrian safety expenses when it hosts NASCAR races, and that credit rises to 100 percent of costs from 2010 onward.

Lynn Jondahl, a former state legislator from Okemos, has been studying the state’s tax loopholes for more than two decades.  Now executive director of the progressive think tank Michigan Prospect, Jondahl still champions increased oversight and public awareness of the tax expenditures he calls “silent spending.”

“Foregone revenue is the same as spending,” said Jondahl, who chaired the House Taxation Committee. In 1990, he co-authored a brief about tax expenditures, suggesting sunset provisions that would curb perpetual tax breaks.

“So that essentially for any tax break, you establish a study and an evaluation of the results. Or, lacking that, the break expires,” he said. “Circumstances change, and not every argument, every day, every year, carries the same weight.  Tax expenditures desperately need to be included if you are talking about the whole picture.”

Jondahl is exasperated with lawmakers who vote cuts for key health and safety areas while failing to support bills that would review silent spending.

“If you’re cutting state troopers and you’re saying to your constituents ‘I didn’t have any choice’ and at the same time saying ‘I can’t look at any of these tax breaks,’ – that just doesn’t make sense.”

A question of priorities

Special interest groups like tax breaks because they often last many years – sometimes indefinitely, some analysts say.  And politicians like them because they don’t sound like out-of-pocket spending the way budget line items do.

But with a shrinking pool of state money to dole out, tax expenditures are increasingly seen as a form of spending that flies under citizens’ radar screens.

Is it more important that interstate trucking firms be exempt from sales tax on vehicles they buy here, or that migrant workers receive health care?  Should inmates incarcerated in Michigan start paying sales tax on goods they buy at the prison stores?  Tax-free goods for prisoners is a $560,000 line item in the state’s silent spending budget for 2009.  Tax-free sales of newspapers, magazines and films leased to movie theaters will cost the state $96 million this year.

Certain items in the tax expenditure budget tend to draw more criticism than others.  Jondahl, for example, recently called out the sales tax exemption for soft drinks, snacks and other items sold from vending machines.  That’s a $28 million annual hit, according to the state’s tax expenditure report.

But Polly Reeber, president of the Michigan Distributors and Vendors Association – the lobbying group for the vending machine industry, among others – points out that similar snack food sold in convenience stores isn’t taxed, either.  The law doesn’t tax groceries, but it does call for sales tax ready-to-consume meals and drinks.

“We’ve about become the poster child for tax expenditures,” said Reeber.  “But those same items are exempt everywhere else in the marketplace.  So I dispute that it’s a tax expenditure in the first place.”

Reeber pointed out that machines selling heated or cooled food do charge sales tax, as do automated coffee stations that dispense by the cup. But packaged snacks and sealed pop bottles should be treated the same whether purchased in grocery stores or from a machine, she said.  The notion that her industry is getting some sort of break is exasperating.

“We recognize that the state is very much in a fiscal crisis, and we support the need to examine our overall tax policy,” she said. “But words like ‘loophole’ are dangerous. Do you start with the premise that everything belongs to the state and they decide what percentage you get to keep?”

A need for review

But while some line items may be eyebrow-raising or easy targets for criticism, most analysts urging tax expenditure reform say the point isn’t to quibble about the merits of individual tax breaks, but rather the process that perpetuates them.

The real issue, they say, is lack of a routine policy for reviewing and changing tax expenditures, which once granted often tend to go on in perpetuity.

“It’s the proverbial third rail,” said Craig Thiel, director of state affairs for the Citizens Research Council of Michigan.  “Taking something away is always a challenge in politics.”

State Sen. Mickey Switalski, D-Roseville, is an outspoken critic of the film incentive and wants more scrutiny of all tax expenditures.  He thinks as much as half a billion dollars a year could be carved out of the expenditure pool.

“We should institutionalize an annual review of them, just like the budget,” he said. “We need to shine the light. It used to be that anyone who discussed that was accused of wanting to raise taxes. But they’re not really taxes, they’re spending under a different name.”

Like Cassis, Switalski is particularly concerned by the refundable tax credits doled out via MEGA.

“I really don’t think people understand that this is money being spent from the treasury, not just taxes being foregone,” he said. “If we had money to burn, it might be worth it.  But we’re in an era where everyone needs to be tightening their belt.”

Cassis agreed. “No more checks in the mail,” she said.

Measuring success

Along with the question of affordability, some analysts are questioning the efficacy of tax incentives in creating or securing jobs.

“One of the major arguments for tax expenditures is that over the long haul they provide for job growth,” Jondahl said. “The logical question is, did you get the job growth out of them?”   He argues that taxes are low on the list of issues for companies contemplating relocating to Michigan; that they are more concerned with the labor pool, transportation and logistics infrastructure, and quality of life issues for relocating workers such as good schools and safe communities.

“If what our economic development efforts provide is tax breaks, end of story, we aren’t going to attract business,” he said.

“It’s really difficult to know how much bang we are getting for our buck,” agreed  Rosaen, of the Anderson Economic Group. “You can say what did happen with a particular program in place, but it’s hard to say what would or would not have happened without it.”

His firm recently critiqued the film credit.

“It’s pretty clear we’re not getting a return on that incentive in the short term.  We’d get a bigger return collecting taxes,” said Rosaen. “The real debate is: Will it pay off in the long term if we as a state want to be in this industry 10 or 20 years from now. Will we ever be able to take the industry off the subsidy and still keep them here?”