Tax breaks are easier to give than take away

By Ken Sikkema

Around Lansing, there’s a growing sense that tax breaks doled out by the Legislature over the past few decades are worth looking at as part of the solution to Michigan’s ongoing budget crisis.

The official name for such tax breaks is “tax expenditures” and Michigan has about $36 billion worth. (Click here for the most recent list.)

But the simple, pragmatic truth regarding these tax breaks is it’s easier to give them than take them away.

This $36 billion list includes a great variety of tax breaks. Some offer cash-flow benefits to the general public, such as the sales tax exemption on groceries and prescription medications, which totals $1.7 billion annually. Others provide economic assistance to identified segments of the public—senior citizens, for example, do not pay taxes on Social Security income ($53 million); a child care credit is available to families with children ($55 million); and the Earned Income Tax Credit ($315 million in 2010) for low-income wage earners.

Other tax breaks benefit specific private-sector industries—like private sports venues, retailers, hybrid engine developers and movie makers. The $36 billion also includes all of the MEGA credits, tax abatements, and other tax reductions incentives provided through the Michigan Economic Development Corporation.

A significant portion of this $36 billion would be extremely difficult to change. Examples:

• Services (except education, health, and nonprofits) exempt are from the sales tax–$7.1 billion
• The Homestead Exemption from property taxes that is a part of Proposal A (which requires a ¾ vote of the legislature to change)–$3.7 billion
• The constitutional exemption of Food and Prescription Drugs from the sales tax mentioned above–$1.7 billion
• Taxable Value Cap on property taxes (as opposed to basing property taxes on “assessed value”), also a part of Proposal A–$3.5 billion

These 4 items alone are almost $16 billion of the $36 billion total.

A number of the proposals offered recently to reduce tax expenditures do not include much in the way of “big ticket” items that would result in significant revenue. The Michigan League for Human Services, for example, advanced a list last spring which totaled about $400 million. It was a list of 22 different items, no single item of which was more than $70 million, and it included 11 separate items worth less than $10 million each. Do we really want to have a debate/discussion of whether to eliminate the “water softener and water cooler exemption” on personal property taxes ($0.5 million) or the “apprenticeship credit” ($0.6 million) on the MBT?

Some of the other items on the list are difficult to quickly explain and frame for a meaningful discussion. What is, for example, “Decouple state business depreciation from feds–$70 million?”

The total list published by the State Budget Office is lengthy—in fact, it contains 162 separate items. Because “tax expenditures” includes so many different things–including credits available to businesses in the MBT, credits individuals can take on their state income tax liability, and various sales tax exemptions—each with its own unique history, public policy implications, stakeholders, and political dynamic, the Granholm administration suggested a 1% reduction across the board earlier this year. The administration also tried to factor in the degree of difficultly in addressing the items on the list by organizing it into three sections: (1) “Straightforward” tax expenditures; (2) “Difficult to Accomplish” tax expenditures; and (3) “Constitutionally Protected” tax expenditures. A 1% reduction in the “Straightforward” tax expenditures netted only $56 million, while a 1% reduction in the “Difficult” ones resulted in $241 million. I question the later number, however, because it included such strange calculations as taxing all services and then taking a 1% reduction from that.

Given all of this, some options for change do remain.

If Michigan leaders wanted to get serious about reducing tax breaks, a pragmatic discussion would have to focus on two questions:

1. Expanding a sales tax to services (potentially a $7 billion question).

2. Reduce or remove tax breaks in three other big-ticket areas: income tax breaks, business tax breaks, and consumption tax breaks (potentially a $4.4 billion question).

Income Tax Expenditures—total of $2.5 billion

• Homestead Property Tax Credit—————————————-$933 million
• Personal Exemption (currently $3,500)——————————-$1.2 billion
• Earned Income Tax Credit (EITC)————————————-$133.5 million in ’09 but $315 million in ‘10

Note: These 3 items alone represent $2.4 billion of a total $2.5 billion in Income Tax expenditures.

Business Privilege Tax Expenditures (essentially credits on a business’s
MBT liability)—total of $1.8 billion

• Small Business Alternative Tax Credit————-$366.9 million
• Compensation Credit———————————-$220.3 million
• Personal Property Tax Credit————————-$155.6 million
• Investment Tax Credit———————————$127.9 million
• Self-Employment Net Earnings Deduction———$127.1 million
• Motion Picture Credit———————————-$116.6 million

Note: These 6 items alone represent $1.1 billion of a total $1.8 billion in Business Privilege tax expenditures.

Consumption Tax Expenditures (credits reducing sales/use taxes)—total of $117.1 million

• Interstate Trucks and Trailers (certain trucks and trailers used out-of-state are exempt from sales/use tax)——————————$38.1 million
• Vending Machines (food sold from vending machines are exempt from sales tax)—————————————————————-$28.5 million
• Collection Fee—Sales and Use Tax (retailers can keep a portion of the sales tax they collect as a collection fee)————————–$15.6 million
• Licensee Expenses—Tobacco (like the collection fee above, tobacco sellers can keep a portion of the tax as a collection fee)———–$16.3 million

Note: These 4 items alone represent $98.5 million of a total $117.1 million in Consumption Tax Expenditures.

Finally, beyond the short-term focus on whether to cut, keep, or expand any of these individual tax breaks, there is a longer-term service that a fiscal agency, or university public policy research team, or think tank could provide… The current tax expenditures have accumulated over time, and it is rare that any kind of review of their effectiveness or value is done. The state needs a systemic way of reviewing these tax expenditures to evaluate their effectiveness and value as measured against other public policy and economic development needs.

Until we do so, the discussion about reducing or eliminating tax expenditures is an exercise in dancing in the dark.

Ken Sikkema is a senior policy fellow at Public Sector Consultants. He served in the Michigan Legislature for 20 years, including eight years as Senate Majority Leader before being term-limited in 2006. He can be reached at ksikkema@pscinc.com.